Standardized Approach for Calculating the Exposure Amount of Derivative Contracts, 4362-4444 [2019-27249]

Download as PDF 4362 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations DEPARTMENT OF THE TREASURY Office of the Comptroller of the Currency 12 CFR Parts 3 and 32 [Docket ID OCC–2018–0030] RIN 1557–AE44 FEDERAL RESERVE SYSTEM 12 CFR Part 217 [Docket No. R–1629] RIN 7100–AF22 FEDERAL DEPOSIT INSURANCE CORPORATION 12 CFR Parts 324 and 327 RIN 3064–AE80 Standardized Approach for Calculating the Exposure Amount of Derivative Contracts The Office of the Comptroller of the Currency, Treasury; the Board of Governors of the Federal Reserve System; and the Federal Deposit Insurance Corporation. ACTION: Final rule. AGENCY: The Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, and the Federal Deposit Insurance Corporation are issuing a final rule to implement a new approach—the standardized approach for counterparty credit risk (SA–CCR)—for calculating the exposure amount of derivative contracts under these agencies’ regulatory capital rule. Under the final rule, an advanced approaches banking organization may use SA–CCR or the internal models methodology to calculate its advanced approaches total risk-weighted assets, and must use SA–CCR, instead of the current exposure methodology, to calculate its standardized total riskweighted assets. A non-advanced approaches banking organization may use the current exposure methodology or SA–CCR to calculate its standardized total risk-weighted assets. The final rule also implements SA–CCR in other aspects of the capital rule. Notably, the final rule requires an advanced approaches banking organization to use SA–CCR to determine the exposure amount of derivative contracts included in the banking organization’s total leverage exposure, the denominator of the supplementary leverage ratio. In addition, the final rule incorporates SA– CCR into the cleared transactions framework and makes other lotter on DSKBCFDHB2PROD with RULES2 SUMMARY: VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 amendments, generally with respect to cleared transactions. DATES: Effective date: April 1, 2020. Mandatory compliance date: January 1, 2022, for advanced approaches banking organizations. FOR FURTHER INFORMATION CONTACT: OCC: Margot Schwadron, Director or Guowei Zhang, Risk Expert, Capital Policy, (202) 649–7106; Kevin Korzeniewski, Counsel, or Ron Shimabukuro, Senior Counsel, Chief Counsel’s Office, (202) 649–5490; or, for persons who are deaf or hearing impaired, TTY, (202) 649–5597. Board: Constance M. Horsley, Deputy Associate Director, (202) 452–5239; David Lynch, Deputy Associate Director, (202) 452–2081; Elizabeth MacDonald, Manager, (202) 475–6316; Michael Pykhtin, Manager, (202) 912– 4312; Mark Handzlik, Lead Financial Institutions Policy Analyst, (202) 475– 6636; Sara Saab, Senior Financial Institutions Policy Analyst II, (202) 872– 4936; or Cecily Boggs, Senior Financial Institutions Policy Analyst II, (202) 530– 6209; Division of Supervision and Regulation; or Mark Buresh, Senior Counsel, (202) 452–5270; Gillian Burgess, Senior Counsel (202) 736– 5564; or Andrew Hartlage, Counsel, (202) 452–6483; Legal Division, Board of Governors of the Federal Reserve System, 20th and C Streets NW, Washington, DC 20551. For the hearing impaired only, Telecommunication Device for the Deaf, (202) 263–4869. FDIC: Bobby R. Bean, Associate Director, bbean@fdic.gov; Irina Leonova, Senior Policy Analyst, ileonova@ fdic.gov; Peter Yen, Senior Policy Analyst, pyen@fdic.gov, Capital Markets Branch, Division of Risk Management Supervision, (202) 898–6888; or Michael Phillips, Counsel, mphillips@fdic.gov; Catherine Wood, Counsel, cawood@ fdic.gov; Supervision Branch, Legal Division, Federal Deposit Insurance Corporation, 550 17th Street NW, Washington, DC 20429. SUPPLEMENTARY INFORMATION: Table of Contents I. Introduction and Overview of the Proposal A. Overview of Derivative Contracts B. The Basel Committee Standard on SA– CCR C. Overview of the Proposal II. Overview of the Final Rule A. Scope and Application of the Final Rule B. Effective Date and Compliance Deadline C. Final Rule’s Interaction With Agency Requirements and Other Proposals III. Mechanics of the Standardized Approach for Counterparty Credit Risk A. Exposure Amount B. Definition of Netting Sets and Treatment of Financial Collateral C. Replacement Cost PO 00000 Frm 00002 Fmt 4701 Sfmt 4702 D. Potential Future Exposure IV. Revisions to the Cleared Transactions Framework A. Trade Exposure Amount B. Treatment of Default Fund Contributions V. Revisions to the Supplementary Leverage Ratio VI. Technical Amendments A. Receivables Due From a QCCP B. Treatment of Client Financial Collateral Held by a CCP C. Clearing Member Exposure When CCP Performance Is Not Guaranteed D. Bankruptcy Remoteness of Collateral E. Adjusted Collateral Haircuts for Derivative Contracts F. OCC Revisions to Lending Limits G. Other Clarifications and Technical Amendments From the Proposal to the Final Rule VII. Impact of the Final Rule VIII. Regulatory Analyses A. Paperwork Reduction Act B. Regulatory Flexibility Act C. Plain Language D. Riegle Community Development and Regulatory Improvement Act of 1994 E. OCC Unfunded Mandates Reform Act of 1995 Determination F. The Congressional Review Act I. Introduction and Overview of the Proposal A. Overview of Derivative Contracts In general, derivative contracts represent agreements between parties either to make or receive payments or to buy or sell an underlying asset on a certain date (or dates) in the future. Parties generally use derivative contracts to mitigate risk, although such transactions may serve other purposes. For example, an interest rate derivative contract allows a party to manage the risk associated with a change in interest rates, while a commodity derivative contract allows a party to fix commodity prices in the future and thereby minimize any exposure attributable to unfavorable movements in those prices. The value of a derivative contract, and thus a party’s exposure to its counterparty, changes over the life of the contract based on movements in the value of the reference rates, assets, indicators or indices underlying the contract (reference exposures). A party with a positive current exposure expects to receive a payment or other beneficial transfer from the counterparty and is considered to be ‘‘in the money.’’ A party that is in the money is subject to the risk that the counterparty will default on its obligations and fail to pay the amount owed under the transaction, which is referred to as counterparty credit risk. In contrast, a party with a zero or negative current exposure does not expect to receive a payment or beneficial transfer from the counterparty E:\FR\FM\24JAR2.SGM 24JAR2 lotter on DSKBCFDHB2PROD with RULES2 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations and is considered to be ‘‘at the money’’ or ‘‘out of the money.’’ A party that has no current exposure to counterparty credit risk may have exposure to counterparty credit risk in the future if the derivative contract becomes ‘‘in the money.’’ Parties to a derivative contract often exchange collateral to mitigate counterparty credit risk. If a counterparty defaults, the nondefaulting party can sell the collateral to offset its exposure. In the derivatives context, collateral may include variation margin and initial margin (also known as independent collateral). Parties exchange variation margin on a periodic basis during the term of a derivative contract, as typically specified in a variation margin agreement or by regulation.1 Variation margin offsets changes in the market value of a derivative contract and thereby covers the potential loss arising from the default of a counterparty. Variation margin may not always be sufficient to cover a party’s positive exposure (e.g., due to delays in receiving collateral), and thus parties may exchange initial margin. Parties typically exchange initial margin at the outset of the derivative contract and in amounts that are expected to reduce the likelihood of a positive exposure amount for the derivative contract in the event of the counterparty’s default, resulting in overcollateralization. To facilitate the exchange of collateral, parties may enter into variation margin agreements that typically provide for a threshold amount and a minimum transfer amount. The threshold amount is the maximum amount by which the market value of the derivative contract can change before a party must collect or post variation margin (in other words, the threshold amount specifies an acceptable amount of undercollateralization). The minimum transfer amount is the smallest amount of collateral that a party must transfer when it is required to exchange collateral under the variation margin agreement. Parties generally apply a discount (also known as a haircut) to non-cash collateral to account for a potential reduction in the value of the collateral during the period between the last exchange of collateral before the close out of the derivative contract (as in the case of default of the counterparty) and replacement of the contract on the market. This period is known as the margin period of risk (MPOR). 1 See, e.g., 12 CFR part 45 (OCC); 12 CFR part 237 (Board); and 12 CFR part 349 (FDIC). VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 Two parties often will enter into a large number of derivative contracts together. In such cases, the parties may enter into a netting agreement to allow for the offsetting of the derivative contracts under the agreement in the event that one of the parties default and to streamline certain aspects of the transactions, including the exchange of collateral. Netting multiple contracts against each other can substantially reduce the exposure if one of the parties were to default. A netting set reflects those derivative contracts that are subject to the same master netting agreement.2 Parties to a derivative contract may also clear their derivative contract through a central counterparty (CCP). The use of central clearing is designed to reduce the risk of engaging in derivative transactions through the multilateral netting of exposures, establishment and enforcement of collateral requirements, and the promotion of market transparency. A party engages with a CCP either as a clearing member or as a clearing member client. A clearing member is a member of, or a direct participant in, a CCP that has authority to enter into transactions with the CCP. A clearing member may act as a financial intermediary with respect to the clearing member client and either take one position with the client and an offsetting position with the CCP (the principal model of clearing) or guarantee the performance of the clearing member client to the CCP (the agency model of clearing). With respect to the latter type of clearing, the clearing member generally is responsible for fulfilling initial and variation margin calls from the CCP on behalf of its client, irrespective of the client’s ability to post such collateral. The capital rule of the Office of the Comptroller of the Currency (OCC), the Board of Governors of the Federal Reserve System (Board), and the Federal Deposit Insurance Corporation (FDIC) (together, the agencies) requires a banking organization to hold regulatory capital based on the exposure amount of its derivative contracts.3 The capital 2 ‘‘Qualifying master netting agreement’’ is defined in §§ l.2 and l.3(d) of the capital rule. See 12 CFR 3.2 and 3.3(d) (OCC); 12 CFR 217.2 and 217.3(d) (Board); and 12 CFR 324.2 and 324.3(d) (FDIC). 3 12 CFR part 3 (OCC); 12 CFR part 217 (Board); 12 CFR part 324 (FDIC). The agencies have codified the capital rule in different parts of title 12 of the CFR, but the internal structure of the sections within each agency’s rule are identical. All references to sections in the capital rule or the proposal are intended to refer to the corresponding sections in the capital rule of each agency. Banking organizations subject to the agencies’ capital rule PO 00000 Frm 00003 Fmt 4701 Sfmt 4702 4363 rule prescribes different approaches for measuring the exposure amount of derivative contracts based on the size and risk profile of a banking organization. All banking organizations are currently required to use the current exposure method (CEM) to determine the exposure amount of a derivative contract for purposes of calculating standardized total risk-weighted assets.4 Certain large banking organizations may use CEM or the internal models methodology (IMM) to determine the exposure amount of a derivative contract for advanced approaches riskweighted assets. In contrast to CEM, IMM is an internal-models-based approach that requires supervisory approval. The capital rule also requires certain large banking organizations to meet a supplementary leverage ratio, measured as the banking organization’s tier 1 capital relative to its total leverage exposure.5 The total leverage exposure measure captures both on- and offbalance sheet assets, including the exposure amount of a banking organization’s derivative contracts as determined under CEM.6 include national banks, state member banks, insured state nonmember banks, savings associations, and top-tier bank holding companies and savings and loan holding companies domiciled in the United States, but exclude banking organizations subject to the Board’s Small Bank Holding Company and Savings and Loan Holding Company Policy Statement (12 CFR part 225, appendix C), and certain savings and loan holding companies that are substantially engaged in insurance underwriting or commercial activities or that are estate trusts, and bank holding companies and savings and loan holding companies that are employee stock ownership plans. The agencies recently adopted a final rule to implement a community bank leverage ratio framework that is applicable, on an optional basis to depository institutions and depository institution holding companies with less than $10 billion in total consolidated assets and that meet certain other criteria. Such banking organizations that opt into the community bank leverage ratio framework will be deemed compliant with the capital rule’s generally applicable requirements and are not required to calculate risk-based capital ratios. See 84 FR 61776 (November 13, 2019). 4 CEM and IMM are also applied in other parts of the capital rule. For example, advanced approaches banking organizations must use CEM to determine the exposure amount of derivative contracts included in total leverage exposure, the denominator of the supplementary leverage ratio. In addition, the capital rule incorporates CEM into the cleared transactions framework and makes other amendments, generally with respect to cleared transactions. See section II.C. of this SUPPLEMENTARY INFORMATION for further discussion. 5 See infra note 23. Banking organizations subject to Category I, Category II, or Category III standards are subject to the supplementary leverage ratio. 6 See 12 CFR 3.10(c)(4) (OCC); 12 CFR 217.10(c)(4) (Board); and 12 CFR 324.10(c)(4) (FDIC). E:\FR\FM\24JAR2.SGM 24JAR2 lotter on DSKBCFDHB2PROD with RULES2 4364 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations B. The Basel Committee Standard on SA–CCR In 2014, the Basel Committee on Banking Supervision released a new approach for calculating the exposure amount of a derivative contract called the standardized approach for counterparty credit risk (SA–CCR) (the Basel Committee standard).7 Under the Basel Committee standard, a banking organization calculates the exposure amount of its derivative contracts at the netting set level, meaning, those contracts that the standard permits to be netted against each other because they are subject to the same qualifying master netting agreement (QMNA), which must meet certain operational requirements.8 The exposure amount of a derivative contract not subject to a QMNA is calculated individually, and thus the derivative contract constitutes a netting set of one. The exposure amount of each netting set is equal to an alpha factor of 1.4 multiplied by the sum of the replacement cost of the netting set and the potential future exposure (PFE) of the netting set: exposure amount = 1.4 * (replacement cost + PFE) For netting sets that are not subject to a variation margin agreement, replacement cost reflects a banking organization’s current on-balance-sheet credit exposure to its counterparty measured as the maximum of the fair value of the derivative contracts within the netting set less the applicable collateral or zero. For netting sets that are subject to a variation margin agreement, the replacement cost of a netting set reflects the maximum possible unsecured exposure amount of the netting set that would not trigger a variation margin call. For the replacement cost calculation, a banking organization recognizes the collateral amount on a dollar-for-dollar basis, subject to any applicable haircuts. PFE reflects a measure of potential changes in a banking organization’s counterparty exposure for a netting set over a specified period. The PFE calculation allows a banking organization to fully or partially offset derivative contracts within the same netting set that share similar risk factors, based on the concept of hedging sets. Under the Basel Committee standard, derivative contracts form a hedging set if they share the same primary risk 7 See ‘‘The standardized approach for measuring counterparty credit risk exposures,’’ Basel Committee on Banking Supervision (March 2014, rev. April 2014), https://www.bis.org/publ/ bcbs279.pdf. 8 See e.g. supra note 2. VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 factor, and therefore, are within the same asset class—interest rate, exchange rate, credit, equity, or commodities. As derivatives within the same asset class are highly correlated and thus have an economic relationship,9 under the Basel Committee standard, derivative contracts within the same hedging set may be able to fully or partially offset each other. To obtain the PFE for each netting set, a banking organization sums the adjusted derivative contract amount of all hedging sets within the netting set using an asset-class specific aggregation formula and multiples that amount by the PFE multiplier. The PFE multiplier decreases exponentially from a value of one as the value of the financial collateral held by the banking organization exceeds the net fair value of the derivative contracts within the netting set, subject to a floor of five percent. Thus, the PFE multiplier accounts for both over-collateralization and the negative fair value amount of the derivative contracts within the netting set. For purposes of calculating the hedging set amount, a banking organization calculates the adjusted notional amount of a derivative contract and multiplies that amount by a corresponding supervisory factor, maturity factor, and supervisory delta to determine a conservative estimate of effective expected positive exposure (EEPE), assuming zero fair value and zero collateral.10 The Basel Committee 9 Derivative contracts within the same asset class share the same primary risk factor, which implies a closer alignment between all of the underlying risk factors and a higher correlation factor. For a directional portfolio, greater alignment between the risk factors would result in a more concentrated risk, leading to a higher exposure amount. For a balanced portfolio, greater alignment between the risk factors would result in more offsetting of risk, leading to a lower exposure amount. 10 Under IMM, an advanced approaches banking organization uses its own internal models to determine the exposure amount of its derivative contracts. The exposure amount under IMM is calculated as the product of the EEPE for a netting set, which is the time-weighted average of the effective expected exposures (EE) profile over a oneyear horizon, and an alpha factor. For the purposes of regulatory capital calculations, the resulting exposure amount is treated as a loan equivalent exposure, which is the amount effectively loaned by the banking organization to the counterparty under the derivative contract. A banking organization arrives at the exposure amount by first determining the EE profile for each netting set. In general, EE profile is determined by computing exposure distributions over a set of future dates using Monte Carlo simulations, and the expectation of exposure at each date is the simple average of all positive Monte Carlo simulated exposures for each date. The expiration of short-term trades can cause the EE profile to decrease, even though a banking organization is likely to replace short-term trades with new trades (i.e., rollover). To account for rollover, a banking organization converts the EE PO 00000 Frm 00004 Fmt 4701 Sfmt 4702 standard uses supervisory factors that reflect the volatilities observed in the derivatives markets during the financial crisis. The supervisory factors reflect the potential variability of the primary risk factor of the derivative contract over a one-year horizon. The maturity factor scales down the default one-year risk horizon of the supervisory factor to the risk horizon appropriate for the derivative contract. For the supervisory delta adjustment, a banking organization applies a positive sign to the derivative contract amount if the derivative contract is long the risk factor and a negative sign if the derivative contract is short the risk factor. A derivative contract is long the primary risk factor if the fair value of the instrument increases when the value of the primary risk factor increases. A derivative contract is short the primary risk factor if the fair value of the instrument decreases when the value of the primary risk factor increases. The assumptions of zero fair value and zero collateral allow for recognition of offsetting and diversification benefits between derivative contracts that share similar risk factors (i.e., long and short derivative contracts within the same hedging set could fully or partially offset one another). C. Overview of the Proposal On October 30, 2018, the agencies published a notice of proposed rulemaking (proposal) to implement SA–CCR 11 in order to provide important improvements to risk sensitivity and calibration relative to CEM.12 In particular, the implementation of SA–CCR is responsive to concerns that CEM has not kept pace with certain market practices that have been adopted, particularly by large banking organizations that are profile for each netting set into an effective EE profile by applying a nondecreasing constraint to the corresponding EE profile over the first year. The nondecreasing constraint prevents the effective EE profile from declining with time by replacing the EE amount at a given future date with the maximum of the EE amounts across this and all prior simulation dates. The EEPE for a netting set is the time-weighted average of the effective EE profile over a one-year horizon. EEPE would be the appropriate loan equivalent exposure in a credit risk capital calculation if the following assumptions were true: There is no concentration risk, systematic market risk, and wrong-way risk (i.e., the size of an exposure is positively correlated with the counterparty’s probability of default). However, these conditions nearly never exist with respect to a derivative contract. Thus, to account for these risks, IMM requires a banking organization to multiply EEPE by 1.4. 11 See 83 FR 64660 (December 17, 2018). 12 The SUPPLEMENTARY INFORMATION set forth in the proposal includes a description of CEM. See id. at 64664. E:\FR\FM\24JAR2.SGM 24JAR2 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations active in the derivatives market.13 The agencies also proposed SA–CCR to provide a method that is less complex and involves less discretion than IMM, which allows banking organizations to use their own internal models to determine the exposure amount of their derivative contracts.14 Although IMM is more risk-sensitive than CEM, IMM is significantly more complex and requires prior supervisory approval.15 The agencies based the core elements of the proposal on the Basel Committee SA– CCR standard.16 The agencies received approximately 58 comments on the proposal from interested parties, including banking organizations, trade groups, members of Congress, and advocacy organizations. Banking organizations and trade groups offered widespread support for the implementation of SA–CCR although they also suggested modifications to various components of the proposal largely to address concerns regarding its calibration. Commenters who supported the proposal also expressed concerns with its proposed implementation schedule and potential interaction with certain other U.S. laws and regulations. Other commenters, including some commercial entities that use derivative contracts to manage risks arising from their business operations (commercial end-users), opposed the proposal or elements of the proposal. Specifically, these commenters expressed concern that the proposal could indirectly increase the fees they pay to enter into derivative transactions to manage commercial risks in order to help offset the regulatory capital costs of such derivative contracts for banking organizations. The commenters asserted that any such effect would be in contravention of separate public policy objectives designed to support the ability of commercial end-users to engage in derivative transactions for risk-management purposes.17 By contrast, other commenters that opposed the proposal expressed concerns that it could reduce capital held against derivative contracts. As discussed in detail below, the agencies are finalizing the proposal with some modifications to address certain concerns raised by commenters. In particular, the final rule removes the alpha factor of 1.4 from the exposure amount calculation for derivative contracts with commercial end-user counterparties. This change will reduce the exposure amount of such derivative contracts by roughly 29 percent, in comparison to similar derivative contracts with a counterparty that is not a commercial end-user. Commenters also raised concerns regarding the proposed netting treatment for settled-to-market derivative contracts.18 The final rule 4365 allows a banking organization to elect, at the netting set level, to treat all such contracts within the same netting set as collateralized-to-market, thus allowing netting of settled-to-market derivative contracts with collateralized-to-market derivative contracts within the same netting set. In order to make the election, a banking organization must treat the settled-to-market derivative contracts as collateralized-to-market derivative contracts for all purposes under the SA–CCR calculation, including by applying the MPOR treatment applicable to collateralized-tomarket derivative transactions.19 Commenters also criticized the proposal’s approach to the recognition of collateral provided to support a derivative contract for purposes of the supplementary leverage ratio. In response to commenters’ concerns, and consistent with changes to the Basel Committee leverage ratio standard that occurred during the comment period, the final rule allows for greater recognition of collateral in the calculation of total leverage exposure relating to client-cleared derivative contracts.20 II. Overview of the Final Rule Figure 1 below provides a high-level overview of SA–CCR under the Final Rule. FIGURE 1—OVERVIEW OF SA–CCR UNDER THE FINAL RULE Purpose ........................................... SA–CCR Mechanics ....................... • The final rule implements the standardized approach for counterparty-credit risk, in a manner consistent with the core elements of the Basel Committee standard. • A banking organization uses SA–CCR (either on a mandatory or an optional basis) to determine the capital requirements for its derivative contracts. Under the final rule, a banking organization using SA–CCR determines the exposure amount for a netting set of derivative contracts as follows: Exposure amount = alpha factor × (replacement cost + potential future exposure) Key Elements of the SA–CCR Formula lotter on DSKBCFDHB2PROD with RULES2 Replacement Cost .......................... The replacement cost of a derivative contract reflects the amount that it would cost a banking organization to replace the derivative contract if the counterparty were to immediately default. Under SA–CCR, replacement cost is based on the fair value of a derivative contract under U.S. GAAP, with adjustments to reflect the exchange of collateral for margined transactions. 13 The agencies initially adopted CEM in 1989. See 54 FR 4168 (January 27, 1989) (Board and OCC); 54 FR 11500 (March 21, 1989) (FDIC). The last significant update to CEM was in 1995. See 60 FR 46170 (September 5, 1995). 14 The SUPPLEMENTARY INFORMATION set forth in the proposal includes a description of IMM. See 83 FR at 64665. 15 See 12 CFR 3.122 (OCC); 12 CFR 217.122 (Board); and 12 CFR 324.122 (FDIC). 16 See supra note 7. 17 See, e.g., The Commodity Exchange Act and the Securities Exchange Act of 1934, as amended by sections 731 and 764, respectively, of the DoddFrank Wall Street Reform and Consumer Protection Act, Public Law 111–203, 124 Stat. 1376, 1703–12, 1784–96 (2010), require the agencies to, in establishing capital and margin requirements for non-cleared swaps, provide an exemption for VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 certain types of counterparties (e.g., counterparties that are not financial entities and are using swaps to hedge or mitigate commercial risks) from the mandatory clearing requirement. See 7 U.S.C. 6s(e)(3)(C); 15 U.S.C. 78o–10(e)(3)(C); see also 12 CFR part 45 (OCC); 12 CFR part 237 (Board); and 12 CFR part 349 (FDIC) (swap margin rule). 18 Settled-to-market derivatives contracts are those entered into between a central counterparty and a banking organization, under which the central counterparty’s rulebook considers daily payments of variation margin as a settlement payment for the exposure that arises from marking the derivative contract to fair value. These payments are similar to traditional exchanges of variation margin, except that the receiving party takes title to the payment from the transferring party rather than holding the assets as collateral, and thus effectively settles the contract. PO 00000 Frm 00005 Fmt 4701 Sfmt 4702 19 Banking organizations that make such an election would apply the maturity factor applicable to margined transactions under the final rule. See also section III.D.4. of this SUPPLEMENTARY INFORMATION. 20 See ‘‘Leverage ratio treatment of client cleared derivatives,’’ Basel Committee on Banking Supervision, June 2019, https://www.bis.org/bcbs/ publ/d467.pdf. See also section V of this SUPPLEMENTARY INFORMATION. 21 A counterparty’s maximum exposure to a netting set subject to a varation margin agreement equals the threshold amount plus minimum transfer amount. 22 Net independent collateral amount (NICA), as described in section III. B of this SUPPLEMENTARY INFORMATION. E:\FR\FM\24JAR2.SGM 24JAR2 4366 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations FIGURE 1—OVERVIEW OF SA–CCR UNDER THE FINAL RULE—Continued Potential Future Exposure .............. Alpha Factor .................................... For un-margined transactions: RC = max{V ¥ C; 0}, where replacement cost (RC) equals the maximum of the fair value of the derivative contract (after excluding any valuation adjustments) (V) less the net amount of any collateral (C) received from the counterparty and zero. For margined transactions: RC = max{V ¥ C; TH + MTA ¥ NICA; 0}, where replacement cost equals the maximum of (1) the sum of the fair values (after excluding any valuation adjustments) of the derivative contracts within the netting set less the net amount of collateral applicable to such derivative contracts; (2) the counterparty’s maximum exposure to the netting set under the variation margin agreement (TH + MTA),21 less the net collateral amount applicable to such derivative contracts (NICA 22); or (3) zero. The potential future exposure of a derivative contract reflects the possibility of changes in the value of the derivative contract over a specified period. Under SA–CCR, the potential future exposure amount is based on the notional amount and maturity of the derivative contract, volatilities observed during the financial crisis for different classes of derivative contracts (i.e., interest rate, exchange rate, credit, equity, and commodity), the exchange of collateral, and full or partial offsetting among derivative contracts that share an economic relationship. PFE = multiplier × aggregated amount, where the PFE multiplier decreases exponentially from a value of 1 to recognize the amount of any excess collateral and the negative fair values of derivative contracts within the netting set. The aggregated amount accounts for full or partial offsetting among derivative contracts within a hedging set that share an economic relationship, as well as observed volatilities in the reference asset, the maturity of the derivative contract, and the correlation between the derivative contract and the reference exposure (i.e., long or short). The alpha factor is a measure of conservatism that is designed to address risks that are not directly captured under SA–CCR, and to ensure that the capital requirement for a derivative contract under SA– CCR is generally not lower than the one produced under IMM. For most derivative contracts, the alpha factor equals 1.4; however, no alpha factor applies to derivative contracts with commercial end-user counterparties. A. Scope and Application of the Final Rule 1. Scoping Criteria lotter on DSKBCFDHB2PROD with RULES2 The capital rule provides two methodologies for determining total risk-weighted assets: The standardized approach, which applies to all banking organizations, and the advanced approaches, which apply only to ‘‘advanced approaches banking organizations,’’ (or banking organizations subject to Category I or Category II standards) 23 as defined 23 The agencies recently adopted a final rule to revise the criteria for determining the applicability of regulatory capital and liquidity requirements for large U.S. and foreign banking organizations (tailoring final rule). Under the tailoring final rule, an advanced approaches banking organization means a banking organization subject to Category I or Category II standards. Category I standards apply to U.S. global systemically important bank holding companies (U.S. GSIBs) and their depository institution subsidiaries, as identified based on the methodology in the Board’s U.S. GSIB surcharge rule. Category II standards apply to banking organizations that are not subject to Category I standards and that have $700 billion or more in total consolidated assets or $75 billion or more in cross-jurisdictional activity and to their depository institution subsidiaries. Category III standards apply to banking organizations that are not subject to Category I or II standards and that have $250 billion or more in total consolidated assets or $75 billion or more in any of nonbank assets, weighted short-term wholesale funding, or off-balance-sheet exposure. Category III standards also apply to depository institution subsidiaries of any holding company subject to Category III standards. Category IV standards apply to banking organizations with total consolidated assets of $100 billion or more, and their depositiory institution subsidiaries, that do not meet any of the criteria for a higher category of standards. See ‘‘Changes to Applicabiltiy Thresholds for Regulatory Capital and Liquidity Requirements,’’ 84 FR 59230 (November 1, 2019). VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 under the capital rule.24 Both the standardized approach and the advanced approaches require a banking organization to determine the exposure amount for derivative contracts transacted through a central counterparty (i.e., cleared transactions) and derivative contracts that are not cleared transactions (i.e., noncleared derivative contracts, otherwise known as over-the-counter derivative contracts).25 As part of the cleared transactions framework, a banking organization also must determine the risk-weighted asset amounts of any contributions or commitments it may have to mutualized loss sharing 24 Standardized total risk-weighted assets serve as a floor for advanced approaches total risk-weighted assets. Advanced approaches banking organizations must therefore calculate total risk-weighted assets under both approaches and use the result that produces a more binding capital requirement. Total risk-weighted assets are the denominator of the riskbased capital ratios; regulatory capital is the numerator. 25 Under the standardized approach, the riskweighted asset amount for a derivative contract currently is the product of the exposure amount of the derivative contract calculated under CEM and the risk weight for the type of counterparty as set forth in the capital rule. See generally 12 CFR 3.35 (OCC); 12 CFR 217.35 (Board); and 12 CFR 324.35 (FDIC). Under the advanced approaches, the riskweighted asset amount for a derivative contract currently is derived using either CEM or the internal models methodology, which multiplies the exposure amount (or exposure at default amount) of the derivative contract by a models-based formula that uses risk parameters determined by a banking organization’s internal methodologies. See generally 12 CFR 3.132 (OCC); 12 CFR 217.132 (Board); and 12 CFR 324.132 (FDIC). PO 00000 Frm 00006 Fmt 4701 Sfmt 4702 agreements with central counterparties (i.e., default fund contributions).26 The proposal would have replaced CEM with SA–CCR in the capital rule for advanced approaches banking organizations. Thus, for purposes of the advanced approaches, an advanced approaches banking organization would have been required to use either SA– CCR or IMM to calculate the exposure amount of its noncleared and cleared derivative contracts and to use SA–CCR to determine the risk-weighted asset amount of its default fund contributions. For purposes of the standardized approach, an advanced approaches banking organization would have been required to use SA–CCR (instead of CEM) to calculate the exposure amount of its noncleared and cleared derivative contracts and to determine the risk-weighted asset amount of its default fund contributions. The proposal also would have revised the total leverage exposure measure of the supplementary leverage ratio by replacing CEM with a modified version of SA–CCR. Banking organizations that are not advanced approaches banking organizations 27 would have had to choose either CEM or SA–CCR to calculate the exposure amount of 26 See 12 CFR 3.35(d) and 3.133(d) (OCC); 12 CFR 217.35(d) and 217.133(d) (Board); and 12 CFR 324.35(d) and 324.133(d) (FDIC). 27 Under this final rule, banking organizations that are not advanced approaches banking organizations (i.e., banking organizations subject to Category III or Category IV standards) are permitted to choose either CEM or SA–CCR for purposes of determining standardized risk-weighted assets. See supra note 23. E:\FR\FM\24JAR2.SGM 24JAR2 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations noncleared and cleared derivative contracts and to determine the riskweighted asset amount of default fund contributions under the standardized approach. Some commenters raised concerns with the proposal’s use of multiple methods—CEM, SA–CCR, and IMM—to determine the exposure amount of derivative contracts. Specifically, commenters stated that including multiple approaches for calculating the exposure amount of derivative contracts in the capital rule creates regulatory burden and increases the potential for competitive inequalities. The commenters asked the agencies to adopt one methodology that all banking organizations would be required to use to determine the exposure amount of derivative contracts or, short of that, to allow all banking organizations (i.e., both advanced approaches and nonadvanced approaches banking organizations) to elect to use any approach—CEM, SA–CCR, or IMM—to determine the exposure amount for all derivative contracts, as long as the approach is permitted or required under any of the agencies’ rules to calculate the exposure amount of derivative contracts. Other commenters, however, supported allowing advanced approaches banking organizations the option to use IMM for noncleared and cleared derivative contracts to facilitate closer alignment with internal riskmanagement practices of banking organizations because, according to the commenters, SA–CCR may not adapt dynamically to changes in market conditions. Some commenters also requested changes to the applicability criteria for a particular methodology under the capital rule. Specifically, commenters asked the agencies to allow advanced approaches banking organizations to use IMM to calculate the exposure amount of derivative contracts under the standardized approach. Some of these commenters also asked the agencies to tailor the application of SA–CCR based on the composition of a banking organization’s derivatives portfolio, rather than solely based on whether the banking organization meets the definition of an advanced approaches banking organization. Limiting all banking organizations to a single methodology would be inconsistent with the agencies’ efforts to tailor the application of the capital rule to the risk profiles of banking organizations.28 In particular, while SA–CCR offers several improvements to the regulatory capital treatment for derivative contracts relative to CEM, it also requires internal systems enhancements and other operational modifications that could be particularly burdensome for smaller, less complex banking organizations. Moreover, allowing banking organizations to use IMM for purposes of determining standardized total risk-weighted assets would be inconsistent with an intended purpose of the standardized approach, which is to serve as a floor to modelderived outcomes under the advanced approaches. The proposal to require advanced approaches banking organizations to use either SA–CCR or IMM to determine the exposure amount of their noncleared and cleared derivative contracts under the advanced approaches provides meaningful flexibility, promotes consistency for banking organizations that have substantial operations in multiple jurisdictions, and facilitates regulatory reporting and the supervisory assessment of an advanced approaches banking organization’s capital management program. An approach that tailors the applicability of SA–CCR 4367 based solely on the composition of a banking organization’s derivatives portfolio, as suggested by commenters, would be inconsistent with these objectives. Consistent with the proposal, the final rule includes CEM, SA–CCR, and IMM as methodologies for banking organizations to use to determine the exposure amount of derivative contracts and prescribes which approach a banking organization must use based on the category of standards applicable to the banking organization.29 As under the capital rule currently, the final rule does not permit advanced approaches banking organizations to use IMM to calculate the exposure amount of derivative contracts under the standardized approach. Under the final rule and as reflected further in Table 1, an advanced approaches banking organization generally may use SA–CCR or IMM for purposes of determining advanced approaches total risk-weighted assets,30 and must use SA–CCR for purposes of determining standardized total riskweighted assets as well as the supplementary leverage ratio. A nonadvanced approaches banking organization may continue to use CEM or elect to use SA–CCR for purposes of the standardized approach and supplementary leverage ratio (as applicable).31 Where a banking organization has the option to choose among the approaches applicable to such banking organization under the capital rule, it must use the same approach for all purposes. As discussed in section II.C of this SUPPLEMENTARY INFORMATION, the agencies will continue to consider the extent to which SA–CCR should be incorporated into areas of the regulatory framework that are not addressed under this final rule in the context of separate rulemakings. TABLE 1—SCOPE AND APPLICABILITY OF THE FINAL RULE Noncleared derivative contracts lotter on DSKBCFDHB2PROD with RULES2 Advanced approaches banking organizations, advanced approaches total risk-weighted assets. Advanced approaches banking organizations, total risk-weighted assets under the standardized approach. 28 See Must use the same approach selected for purposes of noncleared derivative contracts. Must use SA–CCR. Must use SA–CCR ....................... Must use SA–CCR ....................... Must use SA–CCR. id. 30 As reflected in Table 1, an advanced approaches banking organization must use SA–CCR 17:27 Jan 23, 2020 Default fund contribution Option to use SA–CCR or IMM .... 29 Id. VerDate Sep<11>2014 Cleared transactions framework Jkt 250001 to determine its exposure to default fund contributions under the advanced approaches. 31 The tailoring final rule revised the scope of applicability of the supplementary leverage ratio, such that it applies to U.S. and foreign banking organizations subject to Category I, Category II, or PO 00000 Frm 00007 Fmt 4701 Sfmt 4702 Category III standards. See supra notes 5 and 23. The use of SA–CCR for purposes of the supplementary leverage ratio is discussed in greater detail in section V of this SUPPLEMENTARY INFORMATION. E:\FR\FM\24JAR2.SGM 24JAR2 4368 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations TABLE 1—SCOPE AND APPLICABILITY OF THE FINAL RULE—Continued Noncleared derivative contracts Non-advanced approaches banking organizations, total riskweighted assets under the standardized approach. Advanced approaches banking organizations, supplementary leverage ratio. lotter on DSKBCFDHB2PROD with RULES2 Banking organizations subject to Category III capital standards, supplementary leverage ratio. Option to use CEM or SA–CCR ... Cleared transactions framework Must use the same approach selected for purposes of noncleared derivative contracts. Default fund contribution Must use the same approach selected for purposes of noncleared derivative contracts. Must use SA–CCR to determine the exposure amount of derivative contracts for total leverage exposure. Option to use CEM or SA–CCR to determine the exposure amount of derivative contracts for total leverage exposure. A banking organization must use the same approach, CEM or SA–CCR, for purposes of both standardized total risk-weighted assets and the supplementary leverage ratio. 2. Applicability to Certain Derivative Contracts 3. Application to New Derivative Contracts and Immaterial Exposures B. Effective Date and Compliance Deadline The proposal would have required a banking organization to calculate the exposure amount for all derivative contracts to which the banking organization has an exposure. Commenters raised concerns regarding the treatment of certain derivative contracts under the proposal. Specifically, several commenters asked the agencies to exclude from banking organizations’ regulatory capital calculations derivative contracts with commercial end-user counterparties, while other commenters suggested that the final rule should exclude physically settled forward contracts. Other commenters requested that the agencies allow advanced approaches banking organizations to continue to use CEM to calculate the exposure amount of their derivative contracts with commercial end-user counterparties. Excluding certain derivative contracts from the application of the capital rule, as suggested by commenters, would exclude a material source of credit risk from a banking organization’s regulatory capital requirements. Moreover, requiring a banking organization to use the same approach for its entire derivative portfolio when calculating either its standardized or advanced approaches total risk-weighted assets promotes consistency in the regulatory capital treatment of derivative contracts, and facilitates the supervisory assessment of a banking organization’s capital management program.32 Therefore, consistent with the proposal, the final rule does not provide an exclusion for specific types of derivative contracts nor does it permit the use of different methodologies based on the type of derivative contract or counterparty. Under the current capital rule, an advanced approaches banking organization can use CEM for a period of 180 days for material portfolios of new derivative contracts and without time limitations for immaterial portfolios of new derivative contracts to satisfy the requirement that the total exposure amount calculated under IMM must be at least equal to the greater of the expected positive exposure amount under either the modelled stress scenario or the modelled un-stressed scenario multiplied by 1.4.33 Some commenters noted that the proposal did not replace CEM with SA–CCR for these purposes and suggested providing advanced approaches banking organizations the option to consider SA–CCR, in place of CEM, to satisfy the same conservatism requirements. The agencies recognize that an advanced approaches banking organization may need time to develop systems and collect sufficient data to appropriately model the exposure amount for material portfolios of new derivatives under IMM. Therefore, under the final rule, an advanced approaches banking organization that elects to use IMM to calculate the exposure amount of its derivative contracts under the advanced approaches may use SA–CCR for a period of 180 days for material portfolios of new derivative contracts and for immaterial portfolios of such contracts without time limitations.34 This treatment is consistent with the current capital rule. The proposal included a transition period, until July 1, 2020, by which time all advanced approaches banking organizations would have been required to implement SA–CCR; however, both advanced approaches and non-advanced approaches banking organizations would have been able to adopt SA–CCR as of the effective date of the final rule. Several commenters asked the agencies to delay adoption of the final rule. Specifically, some of these commenters asked that the agencies delay adoption until completion of a comprehensive study on the effect of the proposal, including the effect of SA– CCR on commercial end-user counterparties. Other commenters also asked the agencies to delay adoption of SA–CCR, or alternatively, the mandatory compliance date, in order to align its implementation with potential forthcoming changes to the U.S. regulatory capital framework that might be implemented through separate rulemakings.35 These commenters expressed concern that the interaction between SA–CCR and related aspects of the U.S. regulatory capital framework could result in increased capital requirements for banking organizations that are not reflective of underlying risk. In addition, some of these commenters specifically urged the agencies to pair the adoption of SA–CCR with the implementation of the Basel Committee’s revised comprehensive approach for securities financing transactions.36 These commenters argued that banking organizations could use derivative transactions as a substitute for securities financing 32 The final rule does not revise the FR Y–15 report to reflect SA–CCR, as discussed further in section II.C of this SUPPLEMENTARY INFORMATION. VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 33 See 12 CFR 3.132(d)(10) (OCC); 12 CFR 217.132(d)(10) (Board); and 12 CFR 324.132(d)(10) (FDIC). 34 Similar to CEM, as a standardized framework, SA–CCR is designed to produce sufficiently conservative exposure amounts, compared to those calculated under IMM, that satisfy the conservatism requirement under § __.132(d)(10)(i). The final rule also makes similar conforming changes elsewhere in § __.132(d) and (e) to incorporate SA–CCR in the place of CEM. PO 00000 Frm 00008 Fmt 4701 Sfmt 4702 35 For example, the commenters noted potential changes to the regulatory framework as a result of the Basel Committee’s December 2017 release. See ‘‘Basel III: Finalising post-crisis reforms,’’ Basel Committee on Banking Supervision, December 2017, https://www.bis.org/bcbs/publ/d424.pdf. 36 Id. E:\FR\FM\24JAR2.SGM 24JAR2 lotter on DSKBCFDHB2PROD with RULES2 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations transactions and, therefore, adopting SA–CCR without implementing the revised comprehensive approach for securities financing transactions could lead to further concentration in the derivatives market and decreases in the liquidity of the securities financing transactions market. Alternatively, other commenters urged the agencies to set the mandatory compliance date as of January 2022 to align with other anticipated changes to the U.S. regulatory capital framework, and supported allowing banking organizations to adopt SA–CCR or portions of SA–CCR as early as the issuance of the final rule. Additionally, several commenters asked the agencies to align U.S. implementation of SA–CCR with its implementation schedule in other jurisdictions, so as not to disadvantage U.S. banking organizations and their U.S. clients relative to foreign firms. These commenters argued that a mandatory compliance date of January 2022 would ensure internationally consistent implementation of SA–CCR across jurisdictions and allow banking organizations ample time to implement SA–CCR for purposes of both existing regulatory capital requirements and any anticipated forthcoming changes to the U.S. regulatory capital framework. Other commenters suggested extending the mandatory compliance date to January 2022 for banking organizations that use CEM currently and do not have extensive derivatives portfolios. Conversely, several commenters asked the agencies to adopt the proposal as a final rule without delay and to retain the proposed July 2020 mandatory compliance date. Of these, some commenters suggested that the effective date for implementation of SA–CCR should be earlier than July 2020 for the entirety or portions of the SA–CCR rule. These commenters also asked the agencies to provide interim relief through a reduction in risk weights for certain financial products, such as options, if the implementation of SA– CCR is delayed. The agencies anticipate that the final rule will not materially change the amount of capital in the banking system, and that any change in a particular banking organization’s capital requirements, through either an increase or a decrease in regulatory capital, would reflect the enhanced risk sensitivity of SA–CCR relative to CEM, as well as market conditions.37 In addition, SA–CCR provides important 37 The estimated impact of the final rule is described in greater detail in section VII of this SUPPLEMENTARY INFORMATION. VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 improvements to risk sensitivity and calibration relative to CEM and is responsive to concerns that CEM has not kept pace with market practices used by large banking organizations that are active in the derivatives market. Therefore, the agencies are not delaying adoption of the final rule. The agencies intend to monitor the implementation of SA–CCR as part of their ongoing assessment of the effectiveness of the overall U.S. regulatory capital framework to determine whether there are opportunities to reduce burden and improve its efficiency in a manner that continues to support the safety and soundness of banking organizations and U.S. financial stability. However, the agencies recognize that the implementation of SA–CCR requires advanced approaches banking organizations to augment existing systems or develop new ones, as all such banking organizations must adopt SA–CCR for the standardized approach even if they plan to continue using IMM under the advanced approaches. Accordingly, the final rule includes a mandatory compliance date for advanced approaches banking organizations of January 1, 2022, to permit these banking organizations additional time to adjust their systems, as needed, to implement SA–CCR. The final rule also includes an effective date shortly after publication that permits any banking organization to elect to adopt SA–CCR prior to the mandatory compliance date. For this reason, the agencies do not believe that it is necessary to provide any interim adjustments to the current framework. Advanced approaches and nonadvanced approaches banking organizations that adopt SA–CCR prior to the mandatory compliance date must notify their appropriate Federal supervisor. Non-advanced approaches banking organizations that adopt SA– CCR after the mandatory compliance date also must notify their appropriate Federal supervisor. As the final rule does not allow banking organizations to use SA–CCR for a material subset of derivative exposures under either the standardized or advanced approaches, a banking organization cannot early adopt SA–CCR on a partial basis.38 In addition, the technical revisions in the final rule, as described in section VI of this SUPPLEMENTARY INFORMATION, are 38 The final rule allows banking organizations that elect to use SA–CCR to continue to use method 1 or method 2 under CEM to calculate the riskweighted asset amount for default fund contributions until January 1, 2022. See section IV.B. of this SUPPLEMENTARY INFORMATION for a more detailed discussion on the treatment of default fund contributions under the final rule. PO 00000 Frm 00009 Fmt 4701 Sfmt 4702 4369 effective as of the effective date of the final rule. C. Final Rule’s Interaction With Agency Requirements and Other Proposals The implementation of SA–CCR affects other parts of the regulatory framework. Commenters asked that the agencies clarify the interaction between SA–CCR and other existing aspects of the framework that would be affected by the adoption of SA–CCR, including the FDIC’s deposit insurance assessment methodology, the Banking Organization Systemic Risk Report (FR Y–15), the stress test projections in the Board’s Comprehensive Capital Analysis and Review (CCAR) process, and the OCC’s lending limits. Commenters also asked that the agencies clarify the interaction between SA–CCR and potential future revisions to the U.S. regulatory capital framework, including potential implementation of the December 2017 Basel Committee release, Basel III: Finalising post-crisis reforms (Basel III finalization standard),39 and the Board’s stress capital buffer proposal. 1. FDIC Deposit Insurance Assessment Methodology Some commenters noted that the adoption of SA–CCR could affect the FDIC assessment methodology. In response to this comment, the FDIC notes that a lack of historical data on derivative exposure using SA–CCR makes the FDIC unable to incorporate the SA–CCR methodology into the deposit insurance assessment pricing methodology for highly complex institutions 40 upon the effective date of this rule. The FDIC plans to review derivative exposure data reported using SA–CCR, and then consider options for addressing the use of SA–CCR in the deposit insurance assessment system. In the meantime, for purposes of reporting counterparty exposures on Schedule RC–O, memorandum items 14 and 15, 39 See supra note 35. ‘‘highly complex institution’’ is defined as: (1) An insured depository institution (IDI) (excluding a credit card bank) that has had $50 billion or more in total assets for at least four consecutive quarters that either is controlled by a U.S. parent holding company that has had $500 billion or more in total assets for four consecutive quarters, or is controlled by one or more intermediate U.S. parent holding companies that are controlled by a U.S. holding company that has had $500 billion or more in assets for four consecutive quarters; or (2) a processing bank or trust company. A processing bank or trust company is an IDI whose last three years’ non-lending interest income, fiduciary revenues, and investment banking fees, combined, exceed 50 percent of total revenues (and its last three years fiduciary revenues are non-zero), whose total fiduciary assets total $500 billion or more and whose total assets for at least four consecutive quarters have been $10 billion or more. See 12 CFR 327.8(g) and (s). 40 A E:\FR\FM\24JAR2.SGM 24JAR2 4370 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations highly complex institutions must continue to calculate derivative exposures using CEM (as set forth in 12 CFR 324.34(b) under the final rule), but without any reduction for collateral other than cash collateral that is all or part of variation margin and that satisfies the requirements of 12 CFR 324.10(c)(4)(ii)(C)(1)(ii) and (iii) and 324.10(c)(4)(ii)(C)(3)–(7) (as amended under the final rule). Similarly, highly complex institutions must continue to report the exposure amount associated with securities financing transactions, including cleared transactions that are securities financing transactions, using the standardized approach set forth in 12 CFR 324.37(b) or (c) (as amended under the final rule). The FDIC is making technical amendments to its assessment regulations to update crossreferences to CEM and cash collateral requirements in 12 CFR part 324. 2. The Banking Organization Systemic Risk Report (FR Y–15) Some commenters noted that the adoption of SA–CCR could affect reporting on the Banking Organization Systemic Risk Report (FR Y–15), which must be filed by U.S. bank holding companies and certain savings and loan holding companies with $100 billion or more in total consolidated assets and foreign banking organizations with $100 billion or more in combined U.S. assets.41 In particular, these commenters requested that the agencies exclude the alpha factor from the exposure amount calculation under SA–CCR for purposes of the interconnectedness indicator under the FR Y–15. The Board expects to address the use of SA–CCR for purposes of the FR Y–15 in a separate process. Until such time, banking organizations that must report the FR Y– 15 should continue to use CEM to determine the potential future exposure of their derivative contracts for purposes of completing line 11(b) of Schedule B, consistent with the current instructions to the form. lotter on DSKBCFDHB2PROD with RULES2 3. Stress Test Projections in CCAR Commenters asked the Board to clarify how the implementation of SA– CCR will interact with the supervisory stress-testing program. In particular, 41 See Reporting Form FR Y–15, Instructions for Preparation of Banking Organization Systemic Risk Report (reissued December 2016). The Board recently finalized modifications the reporting panel and certain substantive requirements of Form FR Y– 15 in connection with the tailoring final rule adopted by the agencies. See 84 FR 59032 (November 1, 2019) (Board-only final rule to establish risk-based categories for determining prudential standards to large U.S. and foreign banking organizations (Board-only tailoring final rule)); see also supra note 23. VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 some commenters asked the Board to clarify when a banking organization must incorporate SA–CCR into any stress test projections made for purposes of the Comprehensive Capital Analysis and Review (CCAR) exercise relative to the timing of its implementation for regulatory capital purposes. Consistent with past capital planning practice, the Board expects to make revisions so as to not require a banking organization to use SA–CCR for purposes of the CCAR exercise prior to adopting SA–CCR to calculate its risk-based and supplementary leverage capital requirements (as applicable) under the capital rule. To promote comparability of stress test results across banking organizations, for the 2020 stress test cycle all banking organizations would continue to use CEM for the CCAR exercise. However, a banking organization that has elected to adopt SA–CCR in 2020 would be required to use SA–CCR for the CCAR exercise beginning with the 2021 stress test cycle, and those who adopt in 2021 must use SA–CCR for the CCAR exercise beginning with 2022 stress test cycle.42 Finally, a banking organization that does not adopt SA–CCR until the mandatory compliance date in 2022 would not be required to use SA–CCR for the CCAR exercise until the 2023 and all subsequent stress test cycles. Prior to the time of adoption in stress testing, the Board expects to update the Form FR Y–14 to implement these changes and to provide any necessary information on how to incorporate SA– CCR into a banking organization’s stress test results.43 Commenters also suggested aligning certain aspects of the CCAR exercise with SA–CCR. Specifically, commenters asked the Board to revise the CCAR methodology for estimating losses under the largest single counterparty default scenario to distinguish between margined and unmargined counterparty relationships in a manner consistent with SA–CCR. The methodologies for measuring counterparty exposure under SA–CCR and supervisory stress testing are designed to capture different types of risks. In particular, the largest single counterparty default exercise seeks to ensure that a banking organization can absorb losses associated with the default of any counterparty, in addition to 42 For banking organizations subject to Category IV supervisory stress test requirements, 2022 is an on-cycle year. 43 Banking organizations that report information on the FR Y–14 under SA–CCR must do so for all schedules, including DFAST and CCAR. The anticipated standards described in this section would apply equally for purposes of DFAST and CCAR. PO 00000 Frm 00010 Fmt 4701 Sfmt 4702 losses associated with adverse economic conditions, in an environment of economic uncertainty. The Board regularly reviews its stress testing models, and will continue to evaluate the appropriateness of assumptions related to the largest counterparty default component. 4. Swap Margin Rule Commenters noted that the agencies’ margin and capital requirements for covered swap entities rule (swap margin rule) uses a methodology similar to CEM to quantify initial margin requirements for non-cleared swaps and non-cleared security-based swaps.44 This final rule does not affect the swap margin rule or the calculation of appropriate margin and, therefore, the implementation of SA–CCR will not require a banking organization to change the way it complies with those requirements. 5. OCC Lending Limits In the proposal, the OCC proposed to revise its lending limit rule at 12 CFR part 32, to update cross-references to CEM in the standardized approach and to permit SA–CCR as an option for calculation of exposures under lending limits. Commenters generally supported the OCC’s proposal to align measurement of counterparty credit risk across regulatory requirements. The OCC agrees with the commenters and therefore the final rule adopts revisions to the lending limits rule as proposed. 6. Single Counterparty Credit Limit (SCCL) As noted in the proposal, the Board’s single counterparty credit limit (SCCL) rule authorizes a banking organization subject to the SCCL to use any methodology that such a banking organization is authorized to use under the capital rule to determine the credit exposure associated with a derivative contract for purposes of the SCCL rule.45 Thus, as under the proposal, as of the mandatory compliance date for SA– CCR, to determine the credit exposure associated with a derivative contract under the SCCL rule, an advanced approaches banking organization must use SA–CCR or IMM and a banking organization subject to Category III standards, which include the SCCL rule, must use whichever of CEM or SA–CCR 44 See supra note 17. 83 FR 38460 (August 6, 2018). The Boardonly tailoring final rule revised the scope of applicability of the SCCL rule, such that it applies to U.S. and foreign banking organizations subject to Category I, II, or III standards, as applicable, and foreign banking organizations with global consolidated assets of $250 billion or more. See supra note 41. 45 See E:\FR\FM\24JAR2.SGM 24JAR2 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations that it uses to calculate its standardized total risk-weighted assets. 7. Potential Future Revisions to the Agencies’ Rules Commenters requested additional information on the interaction of SA– CCR with other potential revisions that the agencies may make to their respective regulatory capital rules. Potential revisions identified by commenters included the implementation of the Basel III finalization standard and the Board’s proposal to integrate the capital rule and CCAR and stress test rules published in April 2018.46 In addition, the proposed net stable funding ratio rule would cross-reference netting provisions of the agencies’ supplementary leverage ratio that are amended under the final rule.47 The agencies will consider the calibration and operation of SA–CCR for purposes of any such potential revisions through the rulemaking process. lotter on DSKBCFDHB2PROD with RULES2 III. Mechanics of the Standardized Approach for Counterparty Credit Risk A. Exposure Amount Under the proposal, the exposure amount of a netting set would have been equal to an alpha factor of 1.4 multiplied by the sum of the replacement cost of the netting set and the PFE of the netting set. The purposes of the alpha factor were to address certain risks that are not captured under SA–CCR and to ensure that exposure amounts produced under SA–CCR generally would not be lower than those under IMM, in support of its use as a broadly applicable and standardized methodology. In addition, the proposal would have set the exposure amount at zero for a netting set that consists of only sold options in which the counterparty to the options paid the premiums up front and that the options within the netting set are not subject to a variation margin agreement. Commenters stated that the proposal would increase the exposure amount of derivative contracts with commercial end-users, relative to CEM, because commercial end-users often have directional, unmargined derivative portfolios, which would not receive the benefits of collateral recognition and netting under SA–CCR in the form of a reduction to the replacement cost and PFE amounts. As a result, commenters expressed concern that banking organizations would pass the costs of higher capital to commercial end-users in the form of higher fees or, alternatively, that banking organizations 46 See 47 See 83 FR 18160 (April 25, 2018). 81 FR 35124 (June 1, 2016). VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 could be less willing to engage in derivative contracts with commercial end-users who may lack the capability and scale to provide financial collateral recognized under the capital rule. Commenters also expressed concern that any increase in hedging costs for commercial end-users could have an adverse impact on the broader economy. Commenters generally suggested that the agencies address these issues through changes to the alpha factor, either by removing it for all derivative contracts with commercial end-user counterparties, or only for such contracts that are unmargined. Commenters asserted that providing relief for derivative contracts with commercial end-user counterparties would not undermine the goals of the proposal because these transactions comprise a small percentage of outstanding derivatives and may present less risk than other directional, unmargined derivatives. In support of this assertion, commenters argued that commercial end-users typically provide collateral that is not recognized as financial collateral under the capital rule but nonetheless reduces the counterparty credit risk of the underlying transaction.48 Commenters also argued that removing or reducing the alpha factor for such derivative contracts would be consistent with congressional and regulatory efforts designed to facilitate the ability of such counterparties to enter into derivative contracts to manage commercial risks.49 Some commenters argued that applying the alpha factor to derivative contracts with commercial end-user counterparties is misaligned with the risks that the alpha factor was intended to address under IMM, such as wrongway risk.50 Some commenters recommended reducing the alpha factor to 0.65 for derivative contracts with investment grade commercial end-user counterparties, or with non-investment grade commercial end-user counterparties that are supported by a letter of credit or provide a first-priority lien on assets that do not present wrongway risk with respect to the underlying derivative contract. These commenters argued that reducing the alpha factor to 0.65 would improve risk sensitivity and more closely align with the treatment of investment-grade corporate exposures under the revised Basel III finalization standard.51 The agencies recognize that derivative contracts between banking organizations and commercial end-users may include credit risk mitigants that do not qualify as financial collateral under the capital rule.52 In addition, and in contrast to derivative contracts with financial endusers, derivative contracts with commercial end-users have heightened potential to present right-way risk.53 The final rule removes the alpha factor from the exposure amount formula for derivative contracts with commercial end-user counterparties. The agencies intend for this treatment to better align with the counterparty credit risk presented by such exposures due to the presence of credit risk mitigants and the potential for such transactions to present right-way risk. In particular, the agencies recognize that derivative exposures to commercial end-user counterparties may be less likely to present the types of risks that the alpha factor was designed to address, as discussed previously, and therefore believe that removing the alpha factor for such exposures improves the calibration of SA–CCR. The agencies note that this approach also may mitigate the concerns of commenters regarding the potential effects of the proposal relative to congressional and other regulatory actions designed to mitigate the effect that post-crisis derivatives market reforms have on the ability of these parties to enter into derivative contracts to manage commercial risks. The agencies intend to monitor the implementation of SA– CCR as part of their ongoing assessment of the effectiveness of the overall U.S. regulatory capital framework to determine whether there are opportunities to improve the ability of commercial end-users to enter into derivative contracts with banking organizations in a manner that continues to support the safety and soundness of banking organizations and U.S. financial stability. Beyond the concerns related to commercial end-users, commenters 51 See 48 The types of collateral that commercial endusers provide that do not qualify as financial collateral under the capital rule are discussed in further detail in section III.B. of this SUPPLEMENTARY INFORMATION. 49 See supra note 17. 50 Wrong way risk means that the size of an exposure is positively correlated with the counterparty’s probability of default—that is, the exposure amount of the derivative contract increases as the counterparty’s probability of default increases. PO 00000 Frm 00011 Fmt 4701 Sfmt 4702 4371 supra note 3555. § l.2 of the capital rule, financial collateral means cash or liquid and readily marketable securities, in which a banking organization has a perfected first-priority security interest in the collateral. See 12 CFR 3.2 (OCC); 12 CFR 217.2 (Board); and 12 CFR 324.2 (FDIC). 53 Right way risk means that the size of an exposure is negatively correlated with the counterparty’s probability of default—that is, the exposure amount of the derivative contract decreases as the counterparty’s probability of default increases. 52 Under E:\FR\FM\24JAR2.SGM 24JAR2 lotter on DSKBCFDHB2PROD with RULES2 4372 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations recommended other changes to the alpha factor. Several commenters suggested removing the alpha factor from the SA–CCR methodology altogether, whereas other commenters suggested that the alpha factor should apply only to the PFE component. Some commenters supported reducing or eliminating the alpha factor as it applies to all or a subset of derivative contracts. Commenters that recommended removing the alpha factor argued that the rationale for adopting the alpha factor for purposes of IMM does not apply in the context of SA–CCR because, in contrast to IMM, SA–CCR is a non-modelled approach and does not require an adjustment to account for model risk. Similarly, other commenters noted that the alpha factor is less meaningful in the United States because, under the capital rule, the standardized approach serves as a floor to the advanced approaches for total risk-weighted assets. Some of these commenters also stated that the potential elimination of the advanced approaches in connection with the U.S. implementation of the Basel III finalization standard would eliminate use of IMM and undermine the need for the alpha factor. Other commenters argued that because IMM incorporates relatively higher stressed-volatility inputs while the supervisory factors under SA–CCR are static, attempts to have SA–CCR yield a more conservative exposure amount than IMM in all cases could result in SA–CCR producing excessive capital requirements that are disconnected from the actual risk of the underlying exposures. Alternatively, other commenters recommended only applying the alpha factor to PFE. These commenters argued that applying the alpha factor to replacement cost would be inappropriate as the fair value of onbalance sheet derivatives are not subject to model uncertainty. Commenters that supported reducing the alpha factor recommended revising the calibration to reflect the derivatives market reforms that followed the financial crisis, such as mandatory clearing requirements promulgated by the Commodity Futures Trading Commission (CFTC) 54 and the swap margin rule.55 Of these, some commenters supported applying a lower alpha factor to heavily overcollateralized portfolios in order to provide greater collateral recognition. Additionally, some commenters expressed concern that the alpha factor could adversely affect custody banking organizations. In particular, the 54 See 55 See 17 CFR part 50. supra note 17. VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 commenters asserted that custody banking organizations do not maintain large portfolios of derivative contracts across a broad range of tenors (i.e., the amount of time remaining before the end date of the derivative contract) and asset classes and that the foreign exchange derivative portfolio of a custody banking organization is intended to serve the investment needs of the custody banking organization’s clients rather than to take on economic risk. In contrast, some commenters who supported the alpha factor suggested that concerns regarding its impact on the exposure amount calculated under SA–CCR are overstated. Specifically, these commenters argued that banking organizations have incentives to minimize estimates of risk for regulatory capital purposes and that internal models failed to account properly for risk during the crisis and have been criticized in analyses conducted since then. In addition, these commenters stated that although SA–CCR uses estimates of volatility for individual positions that are based on observed, crisis period volatilities, greater recognition of netting and margin under SA–CCR may fully offset any conservatism resulting from the use of updated volatility estimates. As noted in the proposal, the alpha factor helps to instill an appropriate level of conservatism and further support the use of SA–CCR as a broadly applicable and standardized methodology. Additionally, the alpha factor serves to capture certain risks (e.g., wrong-way risk, non-granular risk exposures, etc.) that are not fully reflected under either IMM or SA–CCR. Adopting commenters’ recommendations could reduce the efficacy of SA–CCR as a standardized approach that serves a floor to internal models-based approaches. For large, internationally active banking organizations, consistency with the Basel Committee standard also helps to reduce operational burden and minimize any incentives such banking organizations may have to book activities in legal entities located in jurisdictions that provide relatively more favorable regulatory capital treatment. Accordingly, the final rule incorporates an alpha factor of 1.4 in the exposure amount formula, except as it applies to derivative contracts with commercial end-user counterparties for which the alpha factor is removed under the final rule. The exposure amount formulas are represented as follows: PO 00000 Frm 00012 Fmt 4701 Sfmt 4702 exposure amount = 1.4 * (replacement cost + PFE). However, for a derivative contract with a commercial end-user counterparty, the exposure amount is represented as follows: exposure amount = (replacement cost + PFE). To operationalize the exposure amount formula for derivative contracts with commercial end-user counterparties, the final rule provides a definition of commercial end-user. Under the final rule, a commercial enduser means a company that is using derivatives to hedge or mitigate commercial risk, and is not a financial entity listed in section 2(h)(7)(C)(i)(I) through (VIII) of the Commodity Exchange Act 56 or is not a financial entity listed in section 3C(g)(3)(A)(i) through (viii) of the Securities Exchange Act.57 The definition also includes an entity that qualifies for the exemption from clearing under section 2(h)(7)(A) of the Commodity Exchange Act by virtue of section 2(h)(7)(D) of the Commodity Exchange Act, including entities that are exempted from the definition of financial entity under section 2(h)(7)(C)(iii) of the Commodity Exchange Act; 58 or qualifies for the exemption from clearing under section 3C(g)(1) of the Securities Exchange Act by virtue of section 3C(g)(4) of the Securities Exchange Act.59 Including these entities within the commercial end-user definition permits affiliates that hedge commercial risks on behalf of a parent entity that is not a financial entity to qualify as a commercial enduser, which would accommodate business organizations that hedge commercial risks through transactions conducted by affiliates rather than directly by the parent company. Overall, the definition covers commercial endusers and generally excludes financial entities. This definition has the advantage of being generally consistent with other regulations promulgated by the agencies, including the swap margin rule.60 Referencing provisions of the Commodities Exchange Act or Securities Exchange Act promotes consistency with other regulations and offers a significant compliance benefit to 56 7 U.S.C. 2(h)(7)(C)(i)(I) through (VIII). The commercial end-user definition also applies to transactions with affiliates of entities that enter into derivative contracts on behalf of those entities that meet the criteria under section 2(h)(7)(D) of the Commodity Exchange Act. 57 15 U.S.C. 78c–3(g)(3)(A)(i) through (viii). 58 7 U.S.C. 2(h)(7)(A), (C)(iii), and (D). 59 15 U.S.C. 78c–3(g)(1) and (4). 60 See supra note 17. E:\FR\FM\24JAR2.SGM 24JAR2 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations institutions subject to the final rule.61 In addition, in the swap margin rule context, the agencies observed that differences in risk profiles justified distinguishing between financial endusers and non-financial end-users, on the grounds that financial firms present a higher level of risk than other types of counterparties and are more likely to default during a period of financial stress, thus posing greater risk to the safety and soundness of the counterparty and systemic risk.62 While some commenters requested an exemption for entities that was slightly narrower or broader than the definition the agencies are adopting in the final rule, as noted above, the distinction drawn by this definition is appropriate to differentiate derivative transactions that have the potential to present rightway risk from those that do not.63 Other commenters asked the agencies to clarify that the proposal would apply an exposure amount of zero to sold options in which the counterparty to the options has paid the premiums up front and that are not subject to a variation margin agreement. Consistent with the proposal, under the final rule, an exposure amount of zero applies to sold options that are not subject to a variation margin agreement and for which the counterparty has paid the premiums up front.64 This treatment is appropriate because the counterparty to the option has no future payment obligation under the derivative contract and the banking organization, as the option seller, has no exposure to counterparty credit risk. B. Definition of Netting Sets and Treatment of Financial Collateral Under the capital rule, a netting set is currently defined as a group of transactions with a single counterparty that are subject to a qualifying master netting agreement (QMNA) or a qualifying cross-product master netting agreement. The proposal would have revised the definition of netting set to mean either one derivative contract between a banking organization and a single counterparty, or a group of derivative contracts between a banking organization and a single counterparty that are subject to the same qualifying master netting agreement or the same lotter on DSKBCFDHB2PROD with RULES2 61 The definition of a commercial end-user in the final rule does not extend to an organization exempted by the CFTC pursuant to section 2(h)(7)(C)(ii) of the Commodity Exchange Act (7 U.S.C. 2(h)(7)(C)(ii)) or exempted by the Securities and Exchange Commission pursuant to section 3C(g)(3)(B) of the Securities Exchange Act of 1934 (15 U.S.C. 78c–3(g)(3)(B)). 62 See 80 FR 74839, 74853 (April 1, 2016). 63 Id. 64 See § l.132(c)(5)(iii) of the final rule. VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 qualifying cross-product master netting agreement. The proposal would have allowed a banking organization to calculate the exposure amount of multiple derivative contracts under the same netting set so long as each derivative contract is subject to the same QMNA. Some commenters raised concerns with the proposal’s reliance on netting to reduce exposure amounts on a pointin-time basis instead of on a dynamic basis and suggested revising the proposal to account for situations that may arise during stress periods that could disrupt the availability of netting. As an example, the commenters noted that during the financial crisis some banking organizations requested to novate their ‘‘in-the-money’’ derivative contracts with another counterparty, while leaving the banking organization’s ‘‘out-of-the-money’’ positions with the initial counterparty. The agencies believe it is appropriate to allow for the netting of derivative contracts under SA–CCR on a point-in-time basis, as allowing for netting on a point-in-time basis under SA–CCR is consistent with U.S. generally accepted accounting principles (U.S. GAAP) and facilitates implementation of the final rule. The capital rule relies significantly on banking organizations’ U.S. GAAP balance sheets and thus requires banking organizations to determine capital ratios on a point-in-time basis. The risks related to stress events identified by the commenters may be further addressed in the context of stress testing and resolution planning. Thus, the agencies are adopting as final the netting treatment under the proposal, with the exception of the availability of netting among collateralized-to-market and settled-to-market derivative contracts, which is discussed below in section III.D.4. of this SUPPLEMENTARY INFORMATION. Under the final rule, a group of derivative contracts subject to the same QMNA are part of the same netting set.65 In general, a QMNA means a netting agreement that permits a banking organization to terminate, close-out on a net basis, and promptly liquidate or set off collateral upon an event of default of the counterparty.66 65 The definition of netting set also clarifies that a netting set can be composed of a single derivative contract and retains certain components of the definition that are specific to IMM. 66 See supra note 2. In 2017, the agencies adopted a final rule that requires GSIBs and the U.S. operations of foreign GSIBs to amend their qualified financial contracts to prevent their immediate cancellation or termination if such a banking organization enters bankruptcy or a resolution process. Qualified financial contracts include derivative contracts, securities lending, and short- PO 00000 Frm 00013 Fmt 4701 Sfmt 4702 4373 To qualify as a QMNA, the netting agreement must satisfy certain operational requirements under § l.3 of the capital rule.67 Some commenters expressed concern that the proposed definition of netting set could inadvertently affect the treatment for repo-style transactions under other provisions of the capital rule. The proposed definition was intended to reflect that under SA–CCR a banking organization would determine the exposure amount for a derivative contract at the netting set level, which would have included a single derivative contract. However, to address the commenters’ concern, the agencies have revised the definition of netting set under the final rule to mean a group of transactions with a single counterparty that are subject to a QMNA and, with respect to derivative contracts only, also includes a single derivative contract between a banking organization and a counterparty.68 With respect to repostyle transactions, this definition is consistent with the current capital rule. The proposal set forth definitions for variation margin, variation margin amount, independent collateral, and net independent collateral amount. The proposal would have defined variation margin as financial collateral that is subject to a collateral agreement and provided by one party to its counterparty to meet the performance of the first party’s obligations under one or more derivative contracts between the parties as a result of a change in value of such obligations since the last exchange of such collateral. The variation margin amount would have been equal to the fair value amount of the variation margin that a counterparty to a netting set has posted to a banking organization less the fair value amount of the variation margin posted by the banking organization to the counterparty. The proposal would have required the variation margin amount to be adjusted by the existing standard supervisory haircuts under § l.132(b)(2)(ii)(A)(1) of the capital rule. The standard supervisory haircuts reflect potential term funding transactions such as repurchase agreements. Under the 2017 final rule, the agencies revised the definition of QMNA under the capital rule such that qualified financial contracts could be subject to a QMNA (notwithstanding other operational requirements). See 82 FR 42882 (September 12, 2017). 67 See supra note 2. 68 Consistent with the current definition of netting set, for purposes of the internal models methodology in § l.132(d) of the capital rule, netting set also includes a qualifying cross-product master netting agreement. See 12 CFR 3.132(d) (OCC); 12 CFR 217.132(d) (Board); and 12 CFR 324.132(d) (FDIC). E:\FR\FM\24JAR2.SGM 24JAR2 4374 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations future changes in the value of the financial collateral by adjusting for any potential decrease in the value of the financial collateral received by a banking organization and any potential increase in the value of the financial collateral posted by the banking organization over supervisory-provided holding periods. The standard supervisory haircuts are based on a tenbusiness-day holding period, and the capital rule requires a banking organization to adjust, as applicable, the standard supervisory haircuts to align with the associated derivative contract (or repo-style transaction) according to the formula in § l.132(b)(2)(ii)(A)(4).69 The proposal would have defined independent collateral as financial collateral, other than variation margin, that is subject to a collateral agreement, or in which a banking organization has a perfected, first-priority security interest or, outside of the United States, the legal equivalent thereof (with the exception of cash on deposit and notwithstanding the prior security interest of any custodial agent or any prior security interest granted to a CCP in connection with collateral posted to that CCP), and the amount of which does not change directly in response to the change in value of the derivative contract or contracts that the financial collateral secures. Net independent collateral amount would have been defined as the fair value amount of the independent collateral that a counterparty to a netting set has posted to a banking organization less the fair value amount of the independent collateral posted by the banking organization to the counterparty, excluding such amounts held in a bankruptcy-remote manner,70 or posted to a qualifying central counterparty (QCCP) 71 and held in conformance with the operational requirements in § l.3 of the capital rule. As with the variation margin amount, the independent collateral amount would have been subject to the 69 As described in section III.D. of this the final rule applies a five-day holding period for the purpose of the margin period of risk to all derivative contracts subject to a variation margin agreement that are client-facing derivative transactions, as defined in the final rule, regardless of the method the banking organization uses to calculate the exposure amount of the derivative contract. As described in section VI.E. of this SUPPLEMENTARY INFORMATION, the collateral haircuts for such transactions similarly reflect a five-business-day holding period under the final rule. 70 ‘‘Bankruptcy remote’’ is defined in § l.2 of the capital rule. See 12 CFR 3.2 (OCC); 12 CFR 217.2 (Board); and 12 CFR 324.2 (FDIC). 71 ‘‘Qualifying central counterparty’’ is defined in § l.2 of the capital rule. See 12 CFR 3.2 (OCC); 12 CFR 217.2 (Board); and 12 CFR 324.2 (FDIC). lotter on DSKBCFDHB2PROD with RULES2 SUPPLEMENTARY INFORMATION, VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 standard supervisory haircuts under § l.132(b)(2)(ii)(A)(1) of the capital rule. The agencies did not receive comment on the proposed definitions of variation margin, variation margin amount, independent collateral, and independent collateral amount. Several commenters, however, advocated for recognition of alternative collateral arrangements under SA–CCR to address the potential impact of the proposal on derivative contracts with certain counterparties, including commercial end-users. As noted above, the commenters argued that SA–CCR could unduly increase capital requirements for derivative exposures to commercial enduser counterparties because they often do not provide collateral in the form of cash or liquid and readily marketable securities. Commenters stated that companies, including commercial endusers, regularly use alternative security arrangements, such as liens on assets, a letter of credit, or a parent company guarantee, to offset the counterparty credit risk of their derivative contracts, and that banking organizations should be able to recognize the credit riskmitigating benefits of such arrangements under SA–CCR. In support of their recommendation, commenters noted that a line of credit functions similarly to the exchange of margin because the line of credit is available to be drawn upon by the banking organization in advance of default as the counterparty’s creditworthiness deteriorates. Moreover, the line of credit can be structured so that its amount may increase over the life of the derivative contract based on certain credit quality metrics. Commenters added that common industry practice allows banking organizations to accept these forms of collateral from counterparties and to reflect their credit risk-mitigating benefits when they calculate the exposure amount under IMM. Commenters also argued that derivative contracts with commercial end-users may present right-way risk for banking organizations, in contrast to derivative contracts with financial institution counterparties, and that this feature of these transactions supports recognition of alternative forms of collateral. The capital rule only recognizes certain forms of collateral that qualify as ‘‘financial collateral,’’ as defined under the rule.72 In general, the items that qualify as financial collateral under the capital rule exhibit sufficient liquidity and asset quality to serve as credit risk mitigants for risk-based capital 72 See PO 00000 supra note 52. Frm 00014 Fmt 4701 Sfmt 4702 purposes. Consistent with the capital rule, the final rule does not recognize the alternative collateral arrangements suggested by commenters. Liens and asset pledges, by contrast, may not be rapidly available to support losses in an event of default because the assets they attach to can be illiquid and thus difficult to value and sell for cash after enforcement of a security interest in the collateral or foreclosure, which is inconsistent with the principle that derivatives should be able to be closed out easily and quickly in an event of default.73 In addition, recognizing letters of credit would add significant complexity to the capital rule. In particular, recognition of letters of credit as financial collateral would require the introduction of appropriate qualification criteria, as well as a framework for considering the counterparty credit risk of institutions providing the letters of credit. The agencies also believe that the removal of the alpha factor for derivative contract exposures to commercial end-users helps to address commenters’ concerns that the proposal would have resulted in unduly high risk-weighted asset amounts for derivative contracts with commercial end-user counterparties. Accordingly, the agencies are adopting without change the proposed definitions for variation margin, independent collateral, variation margin amount, and independent collateral amount, as well as the proposed application of the standard supervisory haircuts under the capital rule. C. Replacement Cost The proposal would have provided separate formulas to determine replacement cost that apply depending on whether the counterparty to a banking organization is required to post variation margin. Specifically, the replacement cost for a netting set that is not subject to a variation margin agreement would have equaled the greater of (1) the sum of the fair values (after excluding any valuation adjustments) of the derivative contracts within the netting set, less the net independent collateral amount applicable to such derivative contracts, or (2) zero.74 73 The Board and OCC issued the capital rule as a joint final rule on October 11, 2013 (78 FR 62018) and the FDIC issued the capital rule as a substantially identical interim final rule on September 10, 2013 (78 FR 53340). In April 14, 2014, the FDIC issued the interim final rule as a final rule with no substantive changes (79 FR 20754). 74 Replacement cost is calculated based on the assumption that the counterparty has defaulted. Therefore, this calculation cannot include valuation adjustments based on counterparty’s credit quality, E:\FR\FM\24JAR2.SGM 24JAR2 lotter on DSKBCFDHB2PROD with RULES2 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations For a netting set that is subject to a variation margin agreement where the counterparty is required to post variation margin, replacement cost would have equaled the greater of (1) the sum of the fair values (after excluding any valuation adjustments) of the derivative contracts within the netting set, less the sum of the net independent collateral amount and the variation margin amount applicable to such derivative contracts; (2) the sum of the variation margin threshold and the minimum transfer amount applicable to the derivative contracts within the netting set, less the net independent collateral amount applicable to such derivative contracts; or (3) zero. As noted in the proposal, the formula to determine the replacement cost of a netting set subject to a variation margin agreement would have accounted for the maximum possible unsecured exposure amount of the netting set that would not trigger a variation margin call. For example, a netting set with a high variation margin threshold has a higher replacement cost compared to an equivalent netting set with a lower variation margin threshold. Therefore, the proposal would have provided definitions for variation margin threshold and the minimum transfer amount. Under the proposal, the variation margin threshold would have meant the maximum amount of a banking organization’s credit exposure to its counterparty that, if exceeded, would require the counterparty to post variation margin to the banking organization. The minimum transfer amount would have meant the smallest amount of variation margin that may be transferred between counterparties to a netting set. The proposal included this treatment to address transactions for which the variation margin agreement includes a variation margin threshold that is set at a level high enough to make the netting set effectively unmargined. In such a case, the variation margin threshold would result in an inappropriately high replacement cost, because it is not reflective of the risk associated with the derivative contract but rather the terms of the variation margin agreement. To address this issue, the proposal would have provided that the exposure amount of a netting set subject to a variation margin agreement could not exceed the exposure amount of the same netting set calculated as if such as CVA, which reflect the discounted present value of losses if the counterparty were to default in the future. VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 the netting set were not subject to a variation margin agreement.75 In addition, the proposal would have provided adjustments for determining the replacement cost of a netting set that is subject to multiple variation margin agreements or a hybrid netting set, which is a netting set composed of at least one derivative contract subject to a variation margin agreement under which the counterparty must post variation margin and at least one derivative contract that is not subject to such a variation margin agreement, and for multiple netting sets subject to a single variation margin agreement. Some commenters supported the proposed replacement cost calculation and, in particular, the cap based on the margin exposure threshold and minimum transfer amount. The commenters argued that the unmargined exposure amount more accurately reflects the exposure amount for shortdated trades subject to a higher MPOR, as the close-out period reflected in MPOR cannot be increased beyond the maturity of the transactions. Other commenters advocated subtracting incurred CVA from the exposure amount of a netting set. In support of their recommendation, the commenters noted that IMM allows incurred CVA to be subtracted from EAD, and that the agencies previously extended such treatment to advanced approaches banking organizations that use CEM to calculate advanced approaches riskweighted assets. 75 There could be a situation unrelated to the value of the variation margin threshold in which the exposure amount of a margined netting set is greater than the exposure amount of an equivalent unmargined netting set. For example, in the case of a margined netting set composed of short-term transactions with a residual maturity of ten business days or less, the risk horizon equals the MPOR, which under the final rule is set to a minimum floor of ten business days. The risk horizon for an equivalent unmargined netting set also is set to ten business days because this is the floor for the remaining maturity of such a netting set. However, the maturity factor for the margined netting set is greater than the one for the equivalent unmargined netting set because of the application of a factor of 1.5 to margined derivative contracts. In such an instance, the exposure amount of a margined netting set is more than the exposure amount of an equivalent unmargined netting set by a factor of 1.5, thus triggering the cap. In addition, in the case of margin disputes, the MPOR of a margined netting set is doubled, which could further increase the exposure amount of a margined netting set comprised of short-term transactions with a residual maturity of ten business days or less above an equivalent unmargined netting set. The agencies believe, however, that such instances rarely occur and thus would have minimal effect on banking organizations’ regulatory capital. Therefore, the final rule limits the exposure amount of a margined netting set to no more than the exposure amount of an equivalent unmargined netting set. However, the agencies expect to monitor the application of this treatment under the final rule. PO 00000 Frm 00015 Fmt 4701 Sfmt 4702 4375 The final rule adopts the proposed replacement cost formulas and related definitions, with one modification. The agencies recognize that in determining the fair value of a derivative on a banking organization’s balance sheet, the recognized CVA on the netting set of OTC derivative contracts is intended to reflect the credit quality of the counterparty. The final rule permits advanced approaches banking organizations to reduce EAD, calculated according to SA–CCR, by the recognized CVA on the balance sheet, for the purposes of calculating advanced approaches total risk-weighted assets. This treatment is consistent with the recognition of CVA under CEM as it applies to advanced approaches banking organizations that use CEM for purposes of determining advanced approaches total risk-weighted assets.76 The final rule otherwise adopts without change the proposed replacement cost formulas and related definitions, as well as the proposed treatment to cap the exposure amount for a margined netting set at the maximum exposure amount for an unmargined, but otherwise identical, netting set. Under § l.132(c)(6)(ii) of the final rule, the replacement cost of a netting set that is not subject to a variation margin agreement is represented as follows: replacement cost = max{V¥C; 0}, Where: V is the fair values (after excluding any valuation adjustments) of the derivative contracts within the netting set; and C is the net independent collateral amount applicable to such derivative contracts. The same requirement applies to a netting set that is subject to a variation margin agreement under which the counterparty is not required to post variation margin. For such a netting set, C also includes the negative amount of the variation margin that the banking organization posted to the counterparty (thus increasing replacement cost). For netting sets subject to a variation margin agreement under which the counterparty must post variation margin, the replacement cost formula is provided under § l.132(c)(6)(i) of the final rule and is represented as follows: replacement cost = max{V¥C; VMT + MTA¥NICA; 0}, Where: V is the fair values (after excluding any valuation adjustments) of the derivative contracts within the netting set; 76 See E:\FR\FM\24JAR2.SGM 80 FR 41409 (July 15, 2015). 24JAR2 4376 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations C is the sum of the net independent collateral amount and the variation margin amount applicable to such derivative contracts; VMT is the variation margin threshold applicable to the derivative contracts within the netting set; and MTA is the minimum transfer amount applicable to the derivative contracts within the netting set. NICA is the net independent collateral amount applicable to such derivative contracts. For a netting set that is subject to multiple variation margin agreements, or a hybrid netting set, a banking organization must determine replacement cost using the methodology described in § l.132(c)(11)(i) of the final rule. Under this paragraph, a banking organization must use the standard replacement cost formula (described in § l.132(c)(6)(i) for a netting set subject to a variation margin agreement), except that the variation margin threshold equals the sum of the variation margin thresholds of all the variation margin agreements within the netting set and the minimum transfer amount equals the sum of the minimum transfer amounts of all the variation margin agreements within the netting set. For multiple netting sets subject to a single variation margin agreement, a banking organization must assign a single replacement cost to the multiple netting sets according to the following formula, as provided under § l.132(c)(10)(i) of the final rule: Replacement Cost = max{SNS max{VNS; 0}¥max{CMA; 0}; 0} + max{SNS min{VNS; 0}¥min{CMA; 0}; 0}, lotter on DSKBCFDHB2PROD with RULES2 Where: NS is each netting set subject to the variation margin agreement MA; VNS is the sum of the fair values (after excluding any valuation adjustments) of the derivative contracts within the netting set NS; and CMA is the sum of the net independent collateral amount and the variation margin amount applicable to the derivative contracts within the netting sets subject to the single variation margin agreement. The component max{SNS max{VNS; 0}¥max{CMA; 0}; 0} reflects the exposure amount produced by netting sets that have current positive market value. Variation margin and independent collateral collected from the counterparty to the transaction can offset the current positive market value of these netting sets (i.e., this component contributes to replacement cost only in instances when CMA is positive). However, netting sets that have current negative market value are not allowed to offset the exposure amount. The component max{SNS VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 min{VNS; 0}¥min{CMA; 0}; 0} reflects the exposure amount produced when the banking organization posts variation margin and independent collateral to its counterparty (i.e., this component contributes to replacement cost only in instances when CMA is negative). D. Potential Future Exposure Under the proposal, the PFE for a netting set would have equaled the product of the PFE multiplier and the aggregated amount. To determine the aggregated amount, a banking organization would have been required to determine the hedging set amounts for the derivative contracts within a netting set, where a hedging set is comprised of derivative contracts that share similar risk factors based on asset class (i.e., interest rate, exchange rate, credit, equity, and commodity). The aggregated amount would have equaled the sum of all hedging set amounts within a netting set. Under the proposal, a banking organization would have used a twostep process to determine the hedging set amount for an asset class. First, a banking organization would have determined the composition of a hedging set using the asset class definitions set forth in the proposal. Second, the banking organization would have determined hedging set amount using asset class specific formulas. The hedging set amount formulas require a banking organization to determine an adjusted derivative contract amount for each derivative contract, and to aggregate those amounts to arrive at the hedging set amount for an asset class.77 The final rule adopts the formula for determining PFE as proposed. Under § l.132(c)(7) of the final rule, the PFE of a netting set equals the product of the PFE multiplier and the aggregated amount. The final rule defines the aggregated amount as the sum of all hedging set amounts within the netting set. This formula is represented in the final rule as follows: PFE = PFE multiplier * aggregated amount, Where aggregated amount is the sum of each hedging set amount within the netting set. 77 Section III.D.1. of this SUPPLEMENTARY discusses the methodology for determining the composition of a hedging set using the asset class distinctions set forth in the final rule. Section III.D.2. of this SUPPLEMENTARY INFORMATION discusses the methodology for determining the adjusted derivative contract amount for each derivative contract. Section III.D.3. of this SUPPLEMENTARY INFORMATION discusses the PFE multiplier. Section III.D.4. of this SUPPLEMENTARY INFORMATION discusses the PFE calculation for nonstandard margin agreements. INFORMATION PO 00000 Frm 00016 Fmt 4701 Sfmt 4702 1. Hedging Set Amounts Under the proposal, a banking organization would have determined the hedging set amount by asset class. To specify each asset class, the proposal would have maintained the existing definitions in the capital rule for interest rate, exchange rate, credit, equity, and commodity derivative contracts. The proposal would have provided hedging set definitions for each asset class and sought comment on an alternative approach for the definition and treatment of exchange rate derivative contracts to recognize the economic relationships of exchange rate chains (i.e., when more than one currency pair can offset the risk of another). For example, a Yen/Dollar forward contract and a Dollar/Euro forward contract, taken together, may be economically equivalent, with properly set notional amounts, to a Yen/Euro forward contract when they are subject to the same QMNA. The proposal also would have included separate treatments for volatility derivative contracts and basis derivative contracts. Some commenters recommended that the agencies revise the definitions for interest rate, exchange rate, equity, and commodity derivative contracts for SA– CCR. In particular, the commenters noted that there could be instances in which the existing definitions in the capital rule are not aligned with the primary risk factor for a derivative contract, and therefore would differ from the classifications used under SA– CCR. To address this concern, commenters requested allowing banking organizations to use the primary risk factor for the derivative contract instead of one based on the asset class definitions set forth in the proposal. The final rule maintains the definitions of interest rate, exchange rate, equity, and commodity derivative contracts, as the definitions are largely aligned with existing derivative products and market practices. In addition to being sufficiently broad to capture the various types of derivative contracts, the existing asset class definitions are well-established, wellunderstood, and generally have functioned as intended in the capital rule. The final rule preserves the ability of the primary Federal regulator to address derivative contracts with multiple risk factors by requiring them to be included in multiple hedging sets under § l.132(c)(2)(iii)(H).78 78 The Board is the primary Federal regulator for bank holding companies, savings and loan holding companies, intermediate holding companies of foreign banks, and state member banks; the OCC is the primary Federal regulator for all national banks E:\FR\FM\24JAR2.SGM 24JAR2 lotter on DSKBCFDHB2PROD with RULES2 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations Some commenters supported the alternative treatment for recognizing the economic relationships of exchange rate chains described in the proposal, but only if modified to address any potential overstatement in the exposure amounts produced when creating separate hedging sets for each foreign currency. The agencies believe that the alternative treatment described in the proposal, if modified to incorporate correlation parameters as suggested by commenters, would add a level of complexity to the alternative treatment that would make it inappropriate for use in a standardized framework that is intended for potential implementation by all banking organizations. The agencies further believe that the alternative treatment described in the proposal, if modified to require the maximum of long or short risk positions, would not add meaningful risk sensitivity by not taking into account the correlations between currency risk factors. Therefore, the agencies are adopting as final the asset class and hedging set definitions as proposed. To determine each hedging set amount, a banking organization first must group into separate hedging sets derivative contracts that share similar risk factors based on the following asset classes: Interest rate, exchange rate, credit, equity, and commodity. Basis derivative contracts and volatility derivative contracts require separate hedging sets. A banking organization then must determine each hedging set amount using asset-class specific formulas that allow for full or partial offsetting. If the risk of a derivative contract materially depends on more than one risk factor, whether interest rate, exchange rate, credit, equity, or commodity risk factor, a banking organization’s primary Federal regulator may require the banking organization to include the derivative contract in each appropriate hedging set. Under the final rule, the hedging set amount of a hedging set composed of a single derivative contract equals the absolute value of the adjusted derivative contract amount of the derivative contract. Section l.132(c)(2)(iii) of the final rule provides the respective hedging set definitions. As noted, an exchange rate hedging set means all exchange rate derivative contracts within a netting set that reference the same currency pair. Thus, there could be as many exchange rate hedging sets within a netting set as distinct currency pairs referenced by the and Federal savings associations; and the FDIC is the primary Federal regulatory for all state nonmember banks and savings associations. VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 exchange rate derivative contracts. An interest rate hedging set means all interest rate derivative contracts within a netting set that reference the same reference currency. Thus, there could be as many interest rate hedging sets in a netting set as distinct currencies referenced by the interest rate derivative contracts in the netting set. A credit hedging set would mean all credit derivative contracts within a netting set. Similarly, an equity hedging set means all equity derivative contracts within a netting set. Consequently, there could be at most one equity hedging set and one credit hedging set within a netting set. A commodity hedging set means all commodity derivative contracts within a netting set that reference one of the following commodity categories: Energy, metal, agricultural, or other commodities. Therefore, there could be no more than four commodity derivative contract hedging sets within a netting set. Consistent with the proposal, the final rule sets forth separate treatments for volatility derivative contracts and basis derivative contracts. A basis derivative contract is a non-foreign exchange derivative contract (i.e., the contract is denominated in a single currency) in which the cash flows of the derivative contract depend on the difference between two risk factors that are attributable solely to one of the following derivative asset classes: Interest rate, credit, equity, or commodity. A basis derivative contract hedging set means all basis derivative contracts within a netting set that reference the same pair of risk factors and are denominated in the same currency. In contrast, a volatility derivative contract means a derivative contract in which the payoff of the derivative contract explicitly depends on a measure of volatility for the underlying risk factor of the derivative contract. Examples of volatility derivative contracts include variance and volatility swaps and options on realized or implied volatility. A volatility derivative contract hedging set means all volatility derivative contracts within a netting set that reference one of interest rate, exchange rate, credit, equity, or commodity risk factors, separated according to the requirements under § l.132(c)(2)(iii)(A)–(E) of the final rule. a. Interest Rate Derivative Contracts Under the proposal, the hedging set amount for a hedging set of interest rate derivative contracts would have recognized that interest rate derivative contracts with close tenors (i.e., the amount of time remaining before the PO 00000 Frm 00017 Fmt 4701 Sfmt 4702 4377 end date of the derivative contract) are generally highly correlated, and thus would have provided a greater offset relative to interest rate derivative contracts that do not have close tenors. In particular, the proposed formula for determining the hedging set amount for interest rate derivative contracts would have permitted full offsetting within a tenor category and partial offsetting across tenor categories, with tenor categories of less than one year, between one and five years, and more than five years. The proposal would have applied a correlation factor of 70 percent across adjacent tenor categories and a correlation factor of 30 percent across nonadjacent tenor categories. The tenor of a derivative contract would have been based on the period between the present date and the end date of the derivative contract, where end date would have meant the last date of the period referenced by the derivative contract, or if the derivative contract references another instrument, the period referenced by the underlying instrument. Some commenters asked the agencies to allow banking organizations to recognize interest rate derivative contracts within the same QMNA as belonging to the same interest rate hedging set, even if such derivative contracts reference different currencies. According to the commenters, such an approach would allow banking organizations to recognize the diversification benefits of multicurrency interest rate derivative portfolios. Some of these commenters also suggested potential ways to implement this approach. Under one approach, a banking organization would calculate the maximum exposure for the interest rate derivative contracts within the QMNA under two scenarios using a single-factor model. The first scenario would receive a correlation factor of zero percent across interest rate exposures in different currencies, while the second scenario would receive a correlation factor of 70 percent. The former scenario would produce the largest amount for portfolios balanced across net short and net long currency exposures, while the latter scenario would produce the largest amount for portfolios that primarily consist of net long or net short currency positions. The second approach would use a single-factor model to aggregate interest rate derivative contracts per currency type to recognize correlations across currencies. Alternatively, other commenters stated that yield curve correlations across major currencies could be used to establish correlation E:\FR\FM\24JAR2.SGM 24JAR2 4378 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations factors for interest rate derivative contracts that reference different currencies. These commenters noted that the Basel Committee’s standard on minimum capital requirements for market risk incorporates a correlation parameter to reflect diversification benefits across multi-currency interest rate portfolios.79 These commenters also stated that studies regarding the Basel Committee standard suggest that, by not recognizing any hedging or diversification benefits across currencies, the proposed method to calculate the hedging set amount for interest rate derivatives under SA–CCR is overly conservative. Other commenters criticized the proposal as not providing a sufficient justification for the requirement that interest rate hedging sets must be settled in the same currency to be included within the same hedging set, in contrast to the proposed treatment for credit, commodity, and equity derivative contracts. The fact that a set of derivative contracts are subject to the same QMNA is not determinative of whether hedging benefits across derivative contracts actually exist. Interest rates in different Hedging set amount= [(AddOn~i 1 ) 2 currencies can move in different directions, rendering correlations unstable. In addition, adopting the commenters’ recommendations could add significant complexity to the final rule. The agencies therefore are adopting as final the proposed treatment for determining the hedging set amount of interest rate derivative contracts. Under § l.132(c)(8)(i) of the final rule, a banking organization must calculate the hedging set amount for interest rate derivative contracts according to the following formula: + (AddOn~i 2 )2 + 1 + 0.6 * AddOn~i 1 * Add0n~i 3 )]z, Where: AddOnTB1IR equals the sum of the adjusted derivative contract amounts within the hedging set with an end date of less than one year from the present date; AddOnTB2IR equals the sum of the adjusted derivative contract amounts within the hedging set with an end date of one to five years from the present date; and AddOnTB3IR equals the sum of the adjusted derivative contract amounts within the hedging set with an end date of more than five years from the present date. lotter on DSKBCFDHB2PROD with RULES2 Consistent with the proposal, the final rule also includes a simpler formula that does not provide an offset across tenor categories. Under this approach, the hedging set amount for interest rate derivative contracts equals the sum of the absolute amounts of each tenor category, which is the sum of the adjusted derivative contract amounts within each respective tenor category. The simpler formula always results in a more conservative measure of the hedging set amount for interest rate derivative contracts of different tenor categories, but may be less burdensome for banking organizations with smaller interest rate derivative contract portfolios. A banking organization may use this simpler formula for some or all of its interest rate derivative contracts. highly correlated. Therefore, under the proposal, the formula for determining the hedging set amount for exchange rate derivative contracts would have allowed for full offsetting within the exchange rate derivative contract hedging set. The agencies did not receive comment regarding the formula for determining the hedging set amount for exchange rate derivative contracts, and are adopting it as proposed. Under § l.132(c)(8)(ii) of the final rule, the hedging set amount for exchange rate derivative contracts equals the absolute value of the sum of the adjusted derivative contract amounts within the hedging set. c. Credit Derivative Contracts and Equity Derivative Contracts b. Exchange Rate Derivative Contracts Exchange rate derivative contracts that reference the same currency pair generally are driven by the same market factor (i.e., the exchange spot rate between these currencies) and thus are Under the proposal, a banking organization would have used the same formula to determine the hedging set amount for both its credit derivative contracts and equity derivative contracts. The formula would allow full offsetting for credit or equity contracts that reference the same entity, and partial offsetting when aggregating across distinct reference entities. In addition, the proposal would have provided supervisory correlation parameters for credit derivative contracts and equity derivative contracts based on whether the derivative contract referenced a single-name entity or an index. A single-name derivative would have received a correlation factor of 50 79 See ‘‘Minimum capital requirements for market risk,’’ Basel Committee on Banking Supervision (January 2019, rev. February 2019), https:// www.bis.org/bcbs/publ/d457.pdf. VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 PO 00000 Frm 00018 Fmt 4701 Sfmt 4702 percent, while an index derivative contract would have received a correlation factor of 80 percent to reflect partial diversification of idiosyncratic risk within an index. As noted in the proposal, the pairwise correlation between two entities is the product of the corresponding correlation factors, so that the pairwise correlation between two single-name derivatives is 25 percent, between one single-name and one index derivative is 40 percent, and between two index derivatives is 64 percent. The application of a higher correlation factor does not necessarily result in a higher exposure amount because the proposal generally would have yielded a lower exposure amount for balanced portfolios relative to directional portfolios. Several commenters asked the agencies to allow banking organizations to decompose indices within credit and equity asset classes to reflect the exposure of highly correlated net long and short positions within an index. Under § l.132(c)(5)(vi) of the final rule, a banking organization may elect to decompose indices within credit and equity asset classes, such that a banking organization would treat each component of the index as a separate single-name derivative contract. Thus, under this election, a banking organization would apply the SA–CCR methodology to each component of the index as if it were a separate singlename derivative contract instead of applying the SA–CCR methodology to E:\FR\FM\24JAR2.SGM 24JAR2 ER24JA20.002</GPH> Add0n~i 3 4379 the index derivative contract. This approach provides enhanced risk sensitivity to the SA–CCR framework by allowing for recognition of the hedging benefits provided by the components of an index. In addition, this approach is similar to other aspects of the capital rule.80 The agencies will monitor the application of the decomposition approach, including the correlation assumptions between an index and its components, to ensure that the approach is functioning as intended. Under the final rule, a banking organization must determine the hedging set amount for its credit and equity derivative contracts set forth in § l.132(c)(8)(iii) of the final rule, as follows: Where: k is each reference entity within the hedging set; K is the number of reference entities within the hedging set; AddOn(Refk) equals the sum of the adjusted derivative contract amounts for all derivative contracts within the hedging set that reference reference entity k; and rk equals the applicable supervisory correlation factor, as provided in Table 2. d. Commodity Derivative Contracts The proposal would have required a banking organization to determine the hedging set amount for commodity derivative contracts based on the following four commodity categories: Energy, metal, agricultural and other. The proposal would have permitted full offsetting for all derivative contracts within the same commodity category (i.e., within a hedging set) that reference the same commodity type, and partial offsetting for all derivative contracts within the same commodity category that reference different commodity types. Under the proposal, a commodity type would have referred to a specific commodity within one of the four commodity categories. Additionally, the proposal would not have provided separate supervisory factors for different commodity types within the energy commodity category.81 For example, under the proposal, a hedging set could have been composed of crude oil derivative contracts and electricity derivative contracts, with each subject to the same supervisory factor. A banking organization would have been able to fully offset all crude oil derivative contracts against each other and all electricity derivative contracts against each other (as they reference the same commodity type). In addition, a banking organization would not have been able to offset commodity derivative contracts that are included in different commodity categories (i.e., a forward contract on crude oil cannot hedge a forward contract on corn). Several commenters asked the agencies to clarify the offsetting treatment among the different types of contracts within the energy category (e.g., electricity and oil/gas derivative contracts). Some commenters asked the agencies to allow banking organizations to decompose derivative contracts that reference commodity indices, such that a banking organization would treat each component of the index as a separate single-name derivative contract. Consistent with the proposal, the final rule permits full offsetting for all derivative contracts within a hedging set that reference the same commodity type, and partial offsetting for all derivative contracts within a hedging set that reference different commodity types within the same commodity category.82 This treatment applies consistently to each of the four commodity categories, including energy. For example, electricity derivative contracts within the same hedging set may fully offset each other, whereas electricity derivative contracts and non-electricity derivate contracts (e.g., oil derivative contracts) within the same hedging set may only partially offset each other because they are different commodity types within the same commodity category. In an attempt to appropriately balance risk sensitivity with operational burden, consistent with the proposal, the final rule allows banking organizations to recognize commodity types without regard to characteristics such as location or quality. For example, a banking organization may recognize crude oil as a commodity type, and would not need to distinguish further between West Texas Intermediate and Saudi Light crude oil. In response to comments, § l.132(c)(5)(vi) of the final rule allows a banking organization to elect to decompose commodity indices, such that a banking organization would treat each component of the index as a separate, single-name derivative contract. Thus, under this election, a banking organization would apply the SA–CCR methodology to each component of the index as if it were a separate, single-name derivative contract, instead of applying the SA– CCR methodology to the index derivative contract. This approach provides enhanced risk sensitivity to the SA–CCR framework by allowing for better recognition of hedging benefits provided by the components of an index. In addition, this approach is similar to other aspects of the capital rule.83 The agencies recognize that specifying separate commodity types is operationally difficult; indeed, it is likely infeasible to sufficiently specify all relevant distinctions between commodity types in order to capture all basis risk. Therefore, the agencies will monitor the commodity-type distinctions made within the industry for purposes of both the full offset treatment for commodity derivative contracts of the same type and the decomposition approach for commodity indices, to ensure that they are being applied and functioning as intended. Consistent with the proposal, a banking organization must assign a derivative contract to the ‘‘other’’ commodity category if the derivative contract does not meet the criteria for the energy, metal or agricultural commodity categories. The hedging set amount for commodity derivative contracts would 80 See e.g., 12 CFR 3.53 (OCC); 12 CFR 217.53 (Board); and 12 CFR 324.53 (FDIC). 81 See section III.D.2.b. of this SUPPLEMENTARY INFORMATION for a more detailed discussion on supervisory factors under the final rule. 82 The final rule provides separate supervisory factors for electricity derivative contracts and other types of commodity derivative contracts within the energy category as discussed further in section III.D.2.b.iii. of this SUPPLEMENTARY INFORMATION. VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 PO 00000 Frm 00019 Fmt 4701 Sfmt 4702 83 See E:\FR\FM\24JAR2.SGM supra note 80. 24JAR2 ER24JA20.003</GPH> lotter on DSKBCFDHB2PROD with RULES2 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4380 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations be determined under § l.132(c)(8)(iv) of the final rule, as follows: Hedging set amount Where: k is each commodity type within the hedging set; K is the number of commodity types within the hedging set; AddOn(Typek) equals the sum of the adjusted derivative contract amounts for all derivative contracts within the hedging set that reference commodity type k; and r equals the applicable supervisory correlation factor, as provided in Table 2 of the preamble. lotter on DSKBCFDHB2PROD with RULES2 2. Adjusted Derivative Contract Amount Under the proposal, the adjusted derivative contract amount would have represented a conservative estimate of effective expected positive exposure (EEPE) 84 for a netting set consisting of a single derivative contract, assuming zero market value and zero collateral, that is either positive (if a long position) or negative (if a short position). A banking organization would have calculated the adjusted derivative contract amount as a product of four components: The adjusted notional amount, the applicable supervisory factor, the applicable supervisory delta adjustment, and the applicable maturity factor. The adjusted derivative contact amount for each asset class would have been aggregated under the hedging set amount formulas for each asset class, as described above. The agencies received no comments on this aspect of the proposal, and are finalizing the formula for determining the adjusted derivative contract amount as proposed under § l.132(c)(9) of the final rule. The formula to determine the adjusted derivative contract amount is represented as follows: adjusted derivative contract amount = di * di * MFi * SFi. Where: di is the adjusted notional amount; di is the applicable supervisory delta adjustment; MFi is the applicable maturity factor; and SFi is the applicable supervisory factor. The adjusted notional amount accounts for the size of the derivative 84 See supra note 10. VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 I:=1 (Add0n(Type,J) 2 r, contract and reflects the attributes of the most common derivative contracts in each asset class. The supervisory factor converts the adjusted notional amount of the derivative contract into an EEPE based on the measured volatility specific to each asset class over a oneyear horizon.85 The supervisory delta adjustment accounts for the sensitivity of a derivative contract (scaled to unit size) to the underlying primary risk factor, including the correct sign (positive or negative) to account for the direction of the derivative contract amount relative to the primary risk factor.86 Finally, the maturity factor scales down, if necessary, the derivative contract amount from the standard oneyear horizon used for supervisory factor calibration to the risk horizon relevant for a given contract. a. Adjusted Notional Amount i. Interest Rate and Credit Derivative Contracts Under the proposal, a banking organization would have applied the same formula to interest rate derivative contracts and credit derivative contracts to arrive at the adjusted notional amount. For such contracts, the adjusted notional amount would have equaled the product of the notional amount of the derivative contract, as measured in U.S. dollars, using the exchange rate on the date of the calculation, and the supervisory duration. The supervisory 85 Specifically, the supervisory factors are intended to reflect the EEPE of a single at-themoney linear trade of unit size, zero market value and one-year maturity referencing a given risk factor in the absence of collateral. See supra note 10. 86 Sensitivity of a derivative contract to a risk factor is the ratio of the change in the market value of the derivative contract caused by a small change in the risk factor to the value of the change in the risk factor. In a linear derivative contract, the payoff of the derivative contract moves at a constant rate with the change in the value of the underlying risk factor. In a nonlinear contract, the payoff of the derivative contract does not move at a constant rate with the change in the value of the underlying risk factor. The sensitivity is positive if the derivative contract is long the risk factor and negative if the derivative contract is short the risk factor. PO 00000 Frm 00020 Fmt 4701 Sfmt 4702 duration would have incorporated measures of the number of business days from the present day until the start date for the derivative contract (S), and the number of business days from the present day until the end date for the derivative contract (E). Some commenters argued that the standard notional definition would not produce reasonably accurate exposure estimates of a banking organization’s closeout risk for all types of derivative contracts. These commenters recommended allowing banking organizations to use internal methodologies to determine the adjusted notional amount for derivative contracts that are not specifically covered under the formulas and methodologies set forth in the proposal. The final rule maintains the formulas and methodologies for determining the adjusted notional amount for interest rate and credit derivative contracts, as generally one of these will be applicable for most derivative contracts. However, the agencies recognize that such approaches may not be applicable to all types of derivative contracts, and that a different approach may be necessary to determine the adjusted notional amount of a derivative contract. In such a case, a banking organization must consult with its primary Federal regulator prior to using an alternative approach to the formulas or methodologies set forth in the final rule. Some commenters suggested revising the proposal to provide a separate measure of S for fixed-to-floating interest rate derivative contracts where the floating rate is determined at the beginning of the reset period and paid at the end, defined as the time period until the earliest reset date, measured in years. According to the commenters, the proposal could overestimate the duration for such derivative contracts, as it would include the time period for which the floating rate (and, therefore, the floating leg payment) is captured in the supervisory duration. The commenters also noted that such E:\FR\FM\24JAR2.SGM 24JAR2 ER24JA20.004</GPH> * 1 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations banking organizations. The agencies therefore are adopting as final the proposed treatment for determining the adjusted notional amount of interest rate and credit derivative contracts. Some commenters requested changes to address forward-settling mortgagebacked securities traded in the to-beannounced (TBA) market. Specifically, these commenters asked the agencies to recalibrate the adjusted notional amount for TBA derivative contracts to account for the term of the mortgage loans underlying the securities. Other commenters recommended measuring S for TBA derivative contracts as the timeweighted average term of the mortgages underlying the securities. In response to commenter concerns, the agencies are clarifying that for an interest rate derivative contract or credit derivative contract that is a variable notional swap, including mortgage-backed securities traded in the TBA market, the notional amount is equal to the time-weighted average of the contractual notional amounts of such a swap over the remaining life of the swap. Other commenters recommended measuring the adjusted notional amount for basis derivative contracts as the product of the absolute value of the spread between the two underlying risk Supervisory duration lotter on DSKBCFDHB2PROD with RULES2 Where: S is the number of business days from the present day until the start date for the derivative contract, or zero if the start date has already passed; and E is the number of business days from the present day until the end date for the derivative contract. A banking organization must calculate the supervisory duration for the period that starts at S and ends at E, where S equals the number of business days between the present date and the start date for the derivative contract, or zero if the start date has passed, and E equals the number of business days from the present date until the end date for the derivative contract. The supervisory duration recognizes that interest rate derivative contracts and credit derivative contracts with a longer tenor have a greater degree of variability than an identical derivative contract with a shorter tenor for the same change in the underlying risk factor (interest rate or = max { e factors (positive or negative) and the number of units. According to these commenters, such an approach would better reflect the risk of such transactions because SA–CCR requires the use of floating notional values, and the notional value may change after execution based on increases or decreases in the spread. The commenters also argued that such an approach would be consistent with guidance released by the CFTC regarding the notional amount for locational basis derivative contracts.87 The final rule does not incorporate the commenters’ suggestion, as the purpose of the proposed treatment is to obtain the absolute volatility of the contract price, which is related to each risk factor rather than the spread. The final rule adopts without change the proposed treatment for determining the adjusted notional amount for credit and interest rate derivative contracts. Under § l.132(c)(9)(ii)(A) of the final rule, the adjusted notional amount for such contracts equals the product of the notional amount of the derivative contract, as measured in U.S. dollars using the exchange rate on the date of the calculation, and the supervisory duration. The formula to determine the supervisory duration is as follows: -0.05* (;~ 0 )_ -0.05• (z1~ 0 )) e 0.05 credit spread), and is based on the assumption of a continuous stream of equal payments and a constant continuously compounded interest rate of 5 percent. The exponential function provides discounting for S and E at 5 percent continuously compounded. In all cases, the supervisory duration is floored at ten business days (or 0.04, based on an average of 250 business days per year). For an interest rate derivative contract or a credit derivative contract that is a variable notional swap, the notional amount equals the time-weighted average of the contract notional amounts of such a swap over the remaining life of the swap. For an interest rate derivative contract or a credit derivative contract that is a leveraged swap, in which the notional amounts of all legs of the derivative contract are divided by a factor and all rates of the derivative contract are multiplied by the same } , 0.04 , factor, the notional amount equals the notional amount of an equivalent unleveraged swap. ii. Exchange Rate Derivative Contracts Under the proposal, the adjusted notional amount for an exchange rate derivative contract would have equaled the notional amount of the non-U.S. denominated currency leg of the derivative contract, as measured in U.S. dollars using the exchange rate on the date of the calculation. In general, the non-U.S. dollar denominated currency leg is the source of exchange rate volatility. If both legs of the exchange rate derivative contract are denominated in currencies other than U.S. dollars, the adjusted notional amount of the derivative contract would have been the largest leg of the derivative contract, measured in U.S. dollars. For an exchange rate derivative contract with multiple exchanges of principal, the notional amount would have equaled 87 See CFTC, Division of Swap Dealer and Intermediary Oversight, FAQs About Swap Entities (Oct. 12, 2012), at 1. VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 PO 00000 Frm 00021 Fmt 4701 Sfmt 4702 E:\FR\FM\24JAR2.SGM 24JAR2 ER24JA20.005</GPH> treatment could significantly affect the adjusted notional amount for a shortdated interest rate derivative portfolio. Other commenters recommended changes to the measure of S for basis derivative contracts, for which the floating rates on the reference exposure are set at the beginning of the payment period. Some of these commenters recommended measuring S as the period (in years) as the earliest reset date of the two floating-rate components of the contract, if the reset dates are different. The treatment recommended by the commenters cannot be made applicable to all interest rate derivatives; for example, it would not be appropriate for in arrears swaps, in which the rate is set at the end of the reset period instead of the beginning, and for forward rate agreements. In addition, adopting the commenters’ recommendations could add significant complexity to the final rule because it would require additional parameters in the adjusted notional amount formula that would be used only in certain circumstances. Such an approach would create additional burden for banking organizations that adopt SA–CCR and could adversely affect the agencies’ ability to use SA– CCR to assess comparability across 4381 4382 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations the notional amount of the derivative contract multiplied by the number of exchanges of principal under the derivative contract. The agencies received no comments on the proposed adjusted notional amount for exchange rate derivative contracts, and are adopting it as final under § l.132(c)(9)(ii)(B) of the final rule. iii. Equity and Commodity Derivative Contracts Under the proposal, a banking organization would have applied the same single-factor formula to equity derivative contracts and commodity derivative contracts. For such contracts, the adjusted notional amount would have equaled the product of the fair value of one unit of the reference instrument underlying the derivative contract and the number of such units referenced by the derivative contract. By design, the proposed treatment would have reflected the current price of the underlying reference instrument. For example, if a banking organization has a derivative contract that references 15,000 pounds of frozen concentrated orange juice currently priced at $0.0005 a pound then the adjusted notional amount would be $7.50. For an equity derivative contract or a commodity derivative contract that is a volatility derivative contract, a banking organization would have been required to replace the unit price with the underlying volatility referenced by the volatility derivative contract and replace the number of units with the notional amount of the volatility derivative contract. By design, the proposed treatment would have reflected that the payoff of a volatility derivative contract generally is determined based on a notional amount and the realized or implied volatility (or variance) referenced by the derivative contract and not necessarily the unit price of the underlying reference instrument. The agencies received no comments on the proposed adjusted notional amount for equity and commodity derivative contracts, including instances in which such a contract is a volatility derivative contract, and are adopting it without change under § l.132(c)(9)(ii)(C) of the final rule. Act (Dodd-Frank Act), which prohibits the use of credit ratings in Federal regulations.88 As an alternative, the proposal would have introduced an approach that satisfies section 939A of the Dodd-Frank Act while allowing for a level of granularity among the supervisory factors applicable to singlename credit derivatives that would have been generally consistent with the Basel Committee standard.89 Under the proposal for single-name credit derivative contracts, investment grade derivative contracts would have received a supervisory factor of 0.5 percent, speculative grade derivative contracts would have received a supervisory factor of 1.3 percent, and sub-speculative grade derivative contracts would have received a supervisory factor of 6.0 percent. For credit derivative contracts that reference an index, investment grade derivative contracts would have received 0.38 percent and speculative grade derivative contracts would have received 1.06 percent. The proposal would have revised the capital rule to include definitions for speculative grade and sub-speculative grade (the capital rule already includes a definition for investment grade). The agencies received several comments on the supervisory factors for credit derivative contracts, but no comments on the proposed definitions of speculative grade and sub-speculative grade. Several commenters encouraged the agencies to reconsider the proposed methodology for determining the supervisory factors for single-name credit derivative contracts. As an alternative, the commenters recommended an approach that maps probability of default (PD) bands to the credit rating categories and the corresponding supervisory factors set forth in the Basel Committee standard for single-name credit derivatives, consistent with the approach used to assign a counterparty risk weight under the simple CVA approach in the advanced approaches.90 According to the commenters, this approach would more closely align with the granularity and the supervisory factors provided under the Basel Committee standard, while meeting the requirements of section 939A of the Dodd-Frank Act. b. Supervisory Factor lotter on DSKBCFDHB2PROD with RULES2 i. Credit Derivative Contracts In contrast to the Basel Committee standard, the proposal would not have provided for the use of credit ratings to determine the supervisory factor for credit derivative contracts due to section 939A of the Dodd-Frank Wall Street Reform and Consumer Protection VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 88 See Public Law 111–203, 124 Stat. 1376 (2010), section 939A. This provision is codified as part of the Securities Exchange Act of 1934 at 15 U.S.C. 78o–7. 89 Specifically, the supervisory factors in the Basel Committee’s SA–CCR standard are as follows (in percent): AAA and AA–0.38, A–0.42; BBB–0.54; BB–1.06; B–1.6; CCC–6.0. 90 See 12 CFR 3.132(e)(5) (OCC); 12 CFR 217.132(e)(5) (Board); and 12 CFR 324.132(e)(5) (FDIC). PO 00000 Frm 00022 Fmt 4701 Sfmt 4702 Alternatively, if the agencies declined to adopt the PD band-based approach for purposes of the final rule, the commenters suggested lowering the proposed supervisory factor for investment grade single-name credit derivatives from 0.5 percent to 0.46 percent, to eliminate the impact of rounding (to the nearest tenth) that was conducted for purposes of the proposal. Other commenters suggested aligning the supervisory factor for investment grade single-name credit derivatives to the lowest supervisory factor under the Basel Committee standard, 0.38 percent, based on the view that the most creditworthy issuers in the United States are no more prone to default than the most creditworthy issuers in other jurisdictions. SA–CCR is a standardized approach, and the use of PD bands to assign supervisory factors to single-name credit derivatives would require the use of internal models, which generally are not appropriate for a standardized approach that is intended to be implementable by banking organizations of all sizes. In addition, providing such treatment as an option in SA–CCR could introduce more risk sensitivity solely for more sophisticated banking organizations that currently determine PD for purposes of the advanced approaches, and potentially provide a competitive advantage to such firms and adversely affect the use of SA–CCR to assess comparability across banking organizations. In addition, lowering the supervisory factor for single-name investment grade credit derivatives to 0.38 percent would fail to recognize the meaningful differences in the risks captured by the investment grade category under the proposal and the final rule, relative to the category and supervisory factor that correspond solely to an AAA credit rating under the Basel Committee standard. In response to comments, however, the final rule applies a 0.46 percent supervisory factor to investment grade single-name credit derivative contracts. This change will enhance the precision and risk sensitivity of the final rule, without introducing undue complexity or materially affecting the amount of regulatory capital a banking organization must hold for such derivative contracts relative to the proposal. Therefore, the final rule adopts the supervisory factors for credit derivative contracts, as proposed, with one modification to the supervisory factor for investment grade single-name credit derivative contracts as described above. In addition, the final rule maintains the current definition of investment grade E:\FR\FM\24JAR2.SGM 24JAR2 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations lotter on DSKBCFDHB2PROD with RULES2 in the capital rule, and adopts the proposed definitions for ‘‘speculative grade’’ and ‘‘sub-speculative grade.’’ The supervisory factors are reflected in Table 2 of this SUPPLEMENTARY INFORMATION. The investment grade category generally captures single-name credit derivative contracts consistent with the three highest supervisory factor categories under the Basel Committee standard. The capital rule defines investment grade to mean that the entity to which the banking organization is exposed through a loan or security, or the reference entity with respect to a credit derivative contract, has adequate capacity to meet financial commitments for the projected life of the asset or exposure. Such an entity or reference entity has adequate capacity to meet financial commitments, as the risk of its default is low and the full and timely repayment of principal is expected.91 The speculative grade category generally captures single-name credit derivative contracts consistent with the next two lower supervisory factor categories under the Basel Committee standard. The final rule defines the term speculative grade to mean that the reference entity has adequate capacity to meet financial commitments in the near term, but is vulnerable to adverse economic conditions, such that should economic conditions deteriorate, the reference entity would present elevated default risk. The sub-speculative grade category corresponds to the lowest supervisory factor category under the Basel Committee standard, with the term sub-speculative grade defined under the final rule to mean that the reference entity depends on favorable economic conditions to meet its financial commitments, such that should economic conditions deteriorate, the reference entity likely would default on its financial commitments. Each of these categories includes exposures that perform largely in accordance with the performance criteria that define each category under the final rule, and therefore result in capital requirements that are broadly equivalent to those resulting from application of the supervisory factors under the Basel Committee standard.92 The agencies expect that banking organizations would conduct their own 91 ‘‘Investment grade’’ is defined in § l.2 of the capital rule. See 12 CFR 3.2 (OCC); 12 CFR 217.2 (Board); and 12 CFR 324.2 (FDIC). 92 An empirical analysis for the supervisory factors applied to the investment grade and speculative grade categories is set forth in the SUPPLEMENTARY INFORMATION section of the proposal. See 83 FR 64660, 64675 (December 17, 2018). VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 due diligence to determine the appropriate category for a single-name credit derivative, in view of the performance criteria in the definitions for each category under the final rule. A banking organization may consider the credit rating for a single-name credit derivative in making that determination as part of a multi-factor analysis. In addition, the agencies expect a banking organization to have and retain support for its analysis and assignment of the respective credit categories. ii. Equity Derivative Contracts Under the proposal, single-name equity derivative contracts would have received a supervisory factor of 32 percent and equity derivative contracts that reference an index would have received a supervisory factor of 20 percent. The agencies received several comments regarding the proposed supervisory factors for equity derivative contracts. In general, the commenters recommended various approaches to distinguish among the risks of singlename equity derivative contracts and thereby provide additional granularity in the supervisory factors that correspond to such exposures. The approaches offered by the commenters would distinguish among (1) investment grade and non-investment grade issuers; (2) issuers in advanced and emerging markets; (3) issuers with large market capitalizations and those with small market capitalizations; and (4) issuers in different industry sectors. Some of the approaches suggested by commenters align with the Basel Committee market risk standard.93 Commenters also suggested various permutations of these approaches (e.g., use of sector differentiation in combination with a distinction for advanced and emerging markets). Some commenters provided analysis suggesting that each of these approaches could offer additional granularity and allow for lower supervisory factors for investment grade, advanced markets, and large cap issuers, relative to the supervisory factors under the proposal and the Basel Committee standard. Commenters also suggested incorporating one of the above distinctions into the supervisory factors for equity indices. The agencies acknowledge that certain aspects of the proposal could be revised to enhance its risk sensitivity; however, any such revisions must be balanced against the objectives of simplicity and ensuring comparability among banking organizations that implement SA–CCR. Attempting to define different categories of market 93 See PO 00000 supra note 79. Frm 00023 Fmt 4701 Sfmt 4702 4383 types or allocating exposures across the various alternate categories posed by commenters, and then calibrating supervisory factors associated with each of those sub-categories, would increase the complexity of applying SA–CCR and reduce comparability among banking organizations. Further adjustments to the supervisory factor for equity derivative contracts to align with the revised Basel III market risk standard, as recommended by commenters, potentially could be considered if that standard is implemented in the United States in a future rulemaking. Therefore, the final rule adopts as proposed the supervisory factors for equity derivative contracts, as reflected in Table 2 of the final rule. iii. Commodity Derivative Contracts The proposal would have established four commodity categories: Energy, metals, agriculture, and other. Energy derivative contracts would have received a supervisory factor of 40 percent, whereas derivative contracts in the non-energy commodity categories (i.e., metal, agricultural, and other) each would have received a supervisory factor of 18 percent. The agencies received a number of comments on the proposed supervisory factors for commodity derivative contracts. Several commenters encouraged the agencies to recalibrate the supervisory factors for commodity derivative contracts to reflect the market price of forward contracts, stating that this would better reflect the actual volatility of the commodity derivatives market compared to the market price of spot contracts. According to these commenters, such an approach would reflect the widespread use of commodity derivative contracts in the market, as a way to hedge commodity price risk for months or years into the future. As an alternative to this recommendation, commenters suggested full alignment with the supervisory factors for commodity derivative contracts in the Basel Committee standard, which applies a 40 percent supervisory factor to electricity derivative contracts and an 18 percent supervisory factor to oil/gas derivative contracts, each within the energy category. Other commenters expressed concern that the proposed supervisory factors for commodity derivative contracts were not sufficiently granular. These commenters argued that each of the commodity categories set forth in the proposal would include a wide range of commodity types that present different levels of risk. As a result, the commenters expressed concern that the E:\FR\FM\24JAR2.SGM 24JAR2 4384 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations proposal would overstate the amount of capital that must be held for certain lower-risk commodities, particularly natural gas and certain types of agricultural commodities.94 Several commenters expressed concern that the proposed supervisory factors for commodity derivative contracts would indirectly increase the cost of such contracts for commercial end-user counterparties, who may use commodity derivative contracts to manage commercial risk. In response to comments, the final rule adopts a separate supervisory factor of 18 percent for all energy derivative contracts except for electricity derivative contracts, which receive a supervisory factor of 40 percent. This treatment enhances the risk sensitivity of the supervisory factors for derivative contract types within the energy commodity category in a manner that aligns with the Basel Committee standard.95 The final rule does not revise the other supervisory factors proposed for commodity derivatives, or provide for more granularity in the supervisory factors. In addition to presenting significant challenges and materially increasing the complexity of the framework (as noted in section III.D.1.d. of this SUPPLEMENTARY INFORMATION), revising the proposal to include additional commodity categories for specific commodity types could limit the full offset treatment available to commodity types within the same category. Recalibrating the supervisory factors for commodity derivative contracts to reflect the volatility driven by forward prices also would not be appropriate for all commodity derivative contracts because the value of short-term derivative contracts—which also are prevalent within the market—is driven by spot prices rather than forward prices. Moreover, such an approach would materially deviate from the Basel Committee standard and could create material inconsistencies in the international treatment of derivative contracts across jurisdictions. Any such inconsistencies could create regulatory compliance burdens for large, internationally active banking organizations required to determine capital requirements for derivative 94 See section III.D.1.d. of this SUPPLEMENTARY lotter on DSKBCFDHB2PROD with RULES2 INFORMATION. 95 As described in section III.D.1.d. of this for purposes of calculating the hedging set amount, the final rule permits full offsetting for all derivative contracts within a hedging set that reference the same commodity type, and partial offsetting for all derivative contracts within a hedging set that reference different commodity types within the same commodity category. SUPPLEMENTARY INFORMATION, VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 contracts under multiple regulatory regimes, and could provide incentives for such banking organizations to book commodity derivatives in an entity located in the jurisdiction that provides for the most favorable treatment from a regulatory capital perspective. Other commenters recommended revising the proposal to provide separate recognition for derivative contracts that reference commodity indices. According to these commenters, diversification across different commodities significantly lowers the volatility of a diversified index when compared to the undiversified volatilities of the index constituents. The final rule does not include a specific treatment for commodity indices because they are typically highly heterogeneous depending on their compositions and maturities and, as a result, a single calibration for such a broad asset class will not provide for the risk sensitivity intended by SA– CCR. Under the proposal, a banking organization would have been required to treat a gold derivative contract as a commodity derivative contract rather than an exchange rate derivative contract, and apply a supervisory factor of 18 percent. Several commenters argued for revising the proposal to recognize gold derivative contracts as a type of exchange rate derivative contract. According to the commenters, such treatment would be consistent with CEM, IMM, the Basel Committee’s Basel II accord issued in 2004 (Basel II),96 and industry practice. The commenters also asserted that, similar to currencies, gold serves as a macroeconomic hedge to dynamic market conditions including declining equity prices, inflationary pressures, and political crises. Based on an analysis of price data for gold, silver, nickel and platinum from January 2001 to January 2019, gold exhibits historical volatility levels that are generally consistent with those observed for other metals, and are nearly identical to the historical volatility levels observed for platinum over the same period. Accordingly, treating a gold derivative contract as an exchange rate derivative contract would significantly understate the risk associated with such exposures, notwithstanding their treatment under either Basel II, IMM or CEM. Moreover, the supervisory factors under SA–CCR are calibrated to volatilities observed in 96 See ‘‘International Convergence of Capital Measurement and Capital Standards: A Revised Framework,’’ Basel Committee on Banking Supervision (June 2004), https://www.bis.org/publ/ bcbs107.pdf. PO 00000 Frm 00024 Fmt 4701 Sfmt 4702 the primary risk factor, and are not based on the purpose for which such a derivative contract may be entered into. Therefore, consistent with the proposal, under the final rule a banking organization must treat a gold derivative contract as a commodity derivative contract, with a supervisory factor of 18 percent. The final rule adopts the supervisory factors for commodity derivative contracts, as proposed, with one modification to the supervisory factor for energy derivative contracts that are not electricity derivative contracts as discussed above. The supervisory factors are reflected in Table 2 of this SUPPLEMENTARY INFORMATION and Table 2 to § l.132 of the final rule. iv. Interest Rate Derivative Contracts Under the proposal, interest rate derivative contracts would have received a supervisory factor of 0.5 percent. The agencies did not receive comments on this aspect of the proposal, and are adopting it as proposed, as reflected in Table 2 of this SUPPLEMENTARY INFORMATION. v. Exchange Rate Derivative Contracts Under the proposal, exchange rate derivative contracts would have received a supervisory factor of 4 percent. As noted in the discussion on supervisory factors for commodity derivative contracts, several commenters supported treating gold derivative contracts as a type of exchange rate derivative contract. However, as noted previously, treating a gold derivative as an exchange rate derivative contract would significantly understate the risk associated with such exposures. The agencies are therefore adopting as final the proposal to treat a gold derivative contract as a commodity derivative contract. The agencies did not receive comments on other aspects of the proposed supervisory factors for exchange rate derivative contracts, and are adopting them as final, as reflected in Table 2 of this SUPPLEMENTARY INFORMATION. vi. Volatility Derivative Contracts and Basis Derivative Contracts For volatility derivative contracts, the proposal would have required a banking organization to multiply the applicable supervisory factor based on the asset class related to the volatility measure by a factor of five. This treatment would have recognized that volatility derivative contracts are inherently subject to more price volatility than the underlying asset classes they reference. For basis derivative contracts, the proposal would have required a banking E:\FR\FM\24JAR2.SGM 24JAR2 4385 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations organization to multiply the applicable supervisory factor based on the asset class related to the basis measure by a factor of one half. This treatment would have reflected that the volatility of a basis derivative contract is based on the difference in volatilities of highly correlated risk factors, which would have resulted in a lower volatility than a derivative contract that is not a basis derivative contract. The agencies did not receive comments on the proposed supervisory factors for volatility derivative contracts and basis derivative contracts, and the final rule adopts this aspect of the proposal without change. TABLE 2—SUPERVISORY OPTION VOLATILITY AND SUPERVISORY FACTORS FOR DERIVATIVE CONTRACTS Supervisory option volatility (percent) Asset class Category Type Interest rate ........................... Exchange rate ....................... Credit, single name ............... N/A ........................................ N/A ........................................ Investment grade .................. Speculative grade ................. Sub-speculative grade .......... Investment Grade ................. Speculative Grade ................ N/A ........................................ N/A ........................................ Energy ................................... N/A ........................................ N/A ........................................ N/A ........................................ N/A ........................................ N/A ........................................ N/A ........................................ N/A ........................................ N/A ........................................ N/A ........................................ Electricity ............................... Other ..................................... N/A ........................................ N/A ........................................ N/A ........................................ Credit, index .......................... Equity, index ......................... Commodity ............................ Metals ................................... Agricultural ............................ Other ..................................... 50 15 100 100 100 80 80 120 75 150 70 70 70 70 Supervisory correlation factor (percent) N/A N/A 50 50 50 80 80 50 80 40 40 40 40 40 Supervisory factor 1 (percent) 0.50 4.0 0.46 1.3 6.0 0.38 1.06 32 20 40 18 18 18 18 lotter on DSKBCFDHB2PROD with RULES2 1 The applicable supervisory factor for basis derivative contract hedging sets is equal to one-half of the supervisory factor provided in Table 2, and the applicable supervisory factor for volatility derivative contract hedging sets is equal to 5 times the supervisory factor provided in Table 2. c. Supervisory Delta Adjustment Under the proposal, a banking organization would have applied the supervisory delta adjustment to account for the sensitivity of a derivative contract to the underlying primary risk factor, including the correct sign (positive for long and negative for short) to account for the direction of the derivative contract amount relative to the primary risk factor. Because option contracts are nonlinear, the proposal would have required a banking organization to use the Black-Scholes Model to determine the supervisory delta adjustment. Some commenters argued that use of the Black-Scholes Model is not appropriate for certain path-dependent options, because their price is not determined by a single price but instead is determined by the path of the price for the underlying asset during the option’s tenor. For such path-dependent options, the commenters asked that banking organizations instead be allowed to use existing internal models. Similarly, other commenters requested allowing banking organizations to use modeled volatilities for purposes of the supervisory delta adjustment, rather than the volatilities prescribed by the 97 See supra note 25. the final rule, a banking organization must represent binary options with strike K as the combination of one bought European option and 98 Under VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 proposal. Conversely, other commenters supported the agencies’ proposal with respect to the calibration of supervisory deltas. As generally noted above, SA–CCR is a standardized framework, and the use of internal models to determine option volatility would generally not be appropriate for a standardized approach that is intended to be implementable by all banking organizations and used to facilitate supervisory assessments of comparability across banking organizations. Allowing banking organizations to use internal models for purposes of the final rule would not support these objectives. The agencies note that advanced approaches banking organizations may continue to use IMM, which is a model-based approach, to determine the exposure amount of derivative contracts for purposes of calculating advanced approaches total risk-weighted assets.97 The final rule adopts the supervisory delta adjustment as proposed. Under § l.132(c)(9)(iii) of the final rule, the supervisory delta adjustment for derivative contracts that are not options or collateralized debt obligation tranches must account only for the direction of the derivative contract (positive or negative) with respect to the underlying risk factor, as such contracts are considered to be linear in the primary risk factor. Accordingly, the supervisory delta adjustment equals one if such a derivative contract is long the primary risk factor and negative one if it is short the primary risk factor. As noted above, because options contracts are nonlinear, a banking organization must use the Black-Scholes Model to determine the supervisory delta adjustment for options contracts. However, because the Black-Scholes Model assumes that the underlying risk factor is greater than zero, consistent with the proposal, the final rule incorporates a parameter, lambda (l), so that the Black-Scholes Model may be used where the underlying risk factor has a negative value. In particular, the Black Scholes formula provides a ratio, P/K, as an input to the natural logarithm function. P is the fair value of the underlying instrument and K is the strike price. The natural logarithm function can be defined only for amounts greater than zero, and therefore, a reference risk factor with a negative value (e.g., negative interest rates) would make the supervisory delta adjustment inoperable. one sold European option of the same type as the original option (put or call) with the strike prices set equal to 0.95 * K and 1.05 * K. The size of the position in the European options must be such that the payoff of the binary option is reproduced exactly outside the region between the two strikes. The absolute value of the sum of the adjusted derivative contract amounts of the bought and sold options is capped at the payoff amount of the binary option. PO 00000 Frm 00025 Fmt 4701 Sfmt 4702 E:\FR\FM\24JAR2.SGM 24JAR2 4386 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations Table 3 - Supervisory Delta Adjustment for Options 98 .Buujit Options '1n(Pk t¾)+o.S. a'• T /250) o • JT /250 ' _. ,- 1nGc ( In _., t~ )+0.S• a'• T /250) ., ' a • /t /250 lotter on DSKBCFDHB2PROD with RULES2 99 The same value of l must be used for all i interest rate options that are denominated in the same currency. The value of li for a given currency would be equal to the lowest value L of Pi and Ki of all interest rate options in a given currency that the banking organization has with all counterparties. 100 A collar is a combination of a long position in the stock, a long put option and a short call option, in which the investor gives up the upside on the stock (by selling the call option) to obtain downside protection (through the purchase of the put option). A butterfly spread consists of a long put (call) with a low exercise price, a long put (call) with a high exercise price, and two short puts (calls) with an intermediate exercise price, in which the investor earns a profit if the underlying asset equals the intermediate exercise price of two short puts (calls) but has limited their potential loss to no more than the low exercise price of the long put (call). VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 I Jt p.so J 1n(: !l )+o.s• a2 • T 1zso' · s equals the supervisory option volatility, determined in accordance with Table 2 of the preamble. Consistent with the proposal, under the final rule, for a derivative contract that can be represented as a combination of standard option payoffs (such as collar, butterfly spread, calendar spread, straddle, and strangle),100 a banking organization must treat each standard option component as a separate derivative contract. For a derivative contract that includes multiple-payment options Supervisory delta adjustment Where: A is the attachment point, which equals the ratio of the notional amounts of all underlying exposures that are subordinated to the banking organization’s exposure to the total notional amount of all underlying exposures, expressed as a decimal value between zero and one; 102 and D is the detachment point, which equals one minus the ratio of the notional amounts of all underlying exposures that are senior to the banking organization’s exposure to the total notional amount of a • \ \ Where: F is the standard normal cumulative distribution function; P equals the current fair value of the instrument or risk factor, as applicable, underlying the option; K equals the strike price of the option; T equals the number of business days until the latest contractual exercise date of the option; and l equals zero for all derivative contracts, except that for interest rate options that reference currencies currently associated with negative interest rates l must be equal to max {¥L + 0.1%; 0}; 99 and Gr¾) +O.S • a' • T /2501 a • .,IT /250 J (such as interest rate caps and floors),101 a banking organization must represent each payment option as a combination of effective single-payment options (such as interest rate caplets and floorlets). A banking organization cannot decompose linear derivative contracts (such as swaps) into components. For a derivative contract that is a collateralized debt obligation tranche, a banking organization must determine the supervisory delta adjustment according to the following formula: 15 =--(1 +14*A )*(1 +14*D) ' all underlying exposures, expressed as a decimal value between zero and one. The proposal would have provided separate maturity factors based on whether a derivative contract is subject to a variation margin agreement. For derivative contracts subject to a variation margin agreement, the maturity factor would have been based on the ratio of the supervisory-provided MPOR applicable to the type of derivative contract and 250 business days. The proposal would have defined MPOR as the period from the most recent exchange of collateral under a variation margin agreement with a defaulting counterparty until the A calendar spread consists of a short call (put) option and a long call (put) option on the same underlying stock and with the same exercise price, but with different maturities. If the investor expects limited price movement on the stock in the nearterm but a significant longer-term price increase, the investor will sell the short-dated call option and purchase the long-dated call option. A straddle consists of a long (short) call option and long (short) put option on the same underlying stock, with the same exercise price and with the same maturity, in which the investor pays (receives) two option premiums upfront. In a long straddle, the investor pays two premiums upfront for the options in order to hedge against expected large future stock price moves regardless of direction. In a short straddle, the investor receives two option premiums upfront based on their expectation of low future price volatility. A strangle consists of a call and put option on the same underlying stock and with the same exercise date, but with different exercise prices. The strategy is similar to the straddle, but the investor is purchasing (selling) out-of-the-money options in a strangle, while in a straddle, the investor is purchasing (selling) at-the-money options. 101 An interest rate cap is a series of interest rate call options (‘‘caplets’’) in which the option seller pays the option buyer when the reference rate exceeds the predetermined level in the contract. An interest rate floor is a series of interest rate put options (‘‘floorlets’’) in which the option seller pays the options buyer when the reference rate falls below the contractual floor. 102 In the case of a first-to-default credit derivative, there are no underlying exposures that are subordinated to the banking organization’s exposure and A = 0. In the case of a second-orsubsequent-to-default credit derivative, the smallest (n¥1) notional amounts of the underlying exposures are subordinated to the banking organization’s exposure. The final rule applies a positive sign to the resulting amount if the banking organization purchased the collateralized debt obligation tranche and applies a negative sign if the banking organization sold the collateralized debt obligation tranche. d. Maturity Factor PO 00000 Frm 00026 Fmt 4701 Sfmt 4702 E:\FR\FM\24JAR2.SGM 24JAR2 ER24JA20.007</GPH> Put cs, Sold ER24JA20.006</GPH> Call Optiom Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations derivative contracts are closed out and the resulting market risk is re-hedged. For derivative contracts subject to a variation margin agreement that are not cleared transactions, MPOR would have been floored at ten business days. For derivative contracts subject to a variation margin agreement and that are cleared transactions, MPOR would have been floored at five business days. For derivative contracts not subject to a variation margin agreement, the maturity factor would have been based on the ratio of the remaining maturity of the derivative contract, capped at 250 business days, with the numerator floored at ten business days. Several commenters asked the agencies to clarify whether a fivebusiness-day MPOR floor would apply to the exposure of a clearing member banking organization to its client that arises when the clearing member banking organization is acting as a financial intermediary and enters into an offsetting derivative contract with a CCP or when the clearing member banking organization provides a guarantee to the CCP on the performance of the client on a derivative contract with the CCP. In response to comments, the final rule applies a fivebusiness-day MPOR floor to the exposure of a clearing member banking organization to its client that arises when the clearing member banking organization is acting as a financial intermediary and enters into an offsetting derivative contract with a QCCP or when the clearing member banking organization provides a guarantee to the QCCP on the performance of the client on a derivative contract with the QCCP (defined under this final rule as a ‘‘client-facing derivative transaction,’’ as described below).103 Some commenters noted that the criteria for doubling the MPOR under the proposal is different from the existing criteria under the IMM. Under the proposal, a banking organization would have been required to double the applicable MPOR floor if the derivative contract is subject to an outstanding dispute over margin. Under the IMM, a banking organization must double the applicable MPOR only if over the two previous quarters more than two margin disputes in a netting set have occurred and lasted longer than the MPOR. The agencies are aligning the treatment in the final rule with this approach. Therefore, a banking organization must double the applicable MPOR only if over the two previous quarters more than two margin disputes in a netting set have occurred, and each margin dispute lasted longer than the MPOR.104 This approach is consistent with the treatment under IMM, which has generally functioned as intended. In addition, alignment with IMM will reduce operational burden for firms that are required to use SA–CCR for calculating standardized risk-weighted assets, but have received prior supervisory approval to use IMM to calculate risk-weighted assets under the advanced approaches. Other commenters requested revising the proposal to allow banking organizations to treat all derivative contracts with a commercial end-user counterparty as subject to a variation margin agreement and apply a holding period of no more than ten business days, regardless of whether the derivative contract is subject to a variation margin agreement. The reasons provided by commenters for this request were to help address the types of concerns raised by commenters regarding exposures to commercial enduser counterparties, as discussed previously. The final rule does not provide maturity factors based on the Maturity factor = 4387 type of counterparty to the derivative contract because the agencies intend for the maturity factor to capture the time period to close out a defaulted counterparty and the degree of legal certainty with respect to such close-out period. With respect to comments regarding the MPOR for exposures to commercial end-user counterparties, removing the alpha factor for derivative contracts with such counterparties should help to address the commenters’ concerns. Some commenters asked the agencies to replace the term ‘‘exotic derivative contracts’’ 105 under the proposal with ‘‘derivative contracts that are not easily replaceable’’ in order to allow banking organizations to rely on existing operational processes rather than requiring the establishment of new ones to identify ‘‘exotic derivative contracts.’’ These commenters noted that banking organizations have already established the operational processes necessary for identifying derivative contracts as ‘‘not easily replaceable’’ to comply with other aspects of the capital rule. In response to commenters’ concerns, the agencies are replacing the term ‘‘exotic derivative contract’’ with ‘‘derivative contract that cannot be easily replaced.’’ For the reasons described above, the agencies are adopting as final the proposed maturity factor adjustment under § l.132(c)(9)(iv) of the final rule, subject to the clarifications and revisions discussed above. Under the final rule, for derivative contracts not subject to a variation margin agreement, or derivative contracts subject to a variation margin agreement under which the counterparty to the variation margin agreement is not required to post variation margin to the banking organization, a banking organization must determine the maturity factor using the following formula: min{M;zso} Where M equals the greater of ten business days and the remaining maturity of the contract, as measured in business days. For derivative contracts subject to a variation margin agreement under which the counterparty must post variation margin, a banking organization must determine the maturity factor using the following formula: 103 Section 132(c)(9)(iv)(A)(2)(ii) of the proposed rule text would have applied a five-business-day MPOR floor to cleared transactions subject to a variation margin agreement. In order to capture the longer close-out period required in the event of a central counterparty failure, the final rule text at section 132(c)(9)(iv)(A)(1) provides that MPOR cannot be less than ten business days for transactions subject to a variation margin agreement that are not client-facing derivative transactions. The final rule is consistent with the Basel Committee standard regarding capital requirements for bank exposures to central counterparties and with the treatment of these transactions under the agencies’ implementation of CEM. See infra note 116. 104 The adopted treatment is also consistent with the application of the standard supervisory haircuts under § l.132(b)(2)(ii)(A)(4) of the final rule. 105 Under the proposal, a banking organization would have been required to use a MPOR of 20 business days for a derivative contract that is within a netting set that is composed of more than 5,000 derivative contracts that are not cleared transactions, or if a netting set contains one or more trades involving illiquid collateral or exotic derivative contracts. VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 PO 00000 Frm 00027 Fmt 4701 Sfmt 4702 E:\FR\FM\24JAR2.SGM 24JAR2 ER24JA20.008</GPH> lotter on DSKBCFDHB2PROD with RULES2 250 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations = -32 .JMPOR -250- , Where MPOR refers to the period from the most recent exchange of collateral under a variation margin agreement with a defaulting counterparty until the derivative contracts are closed out and the resulting market risk is re-hedged. The final rule introduces the term ‘‘client-facing derivative transactions’’ to describe the exposure of a clearing member banking organization to its client that arises when the clearing member banking organization is either acting as a financial intermediary and enters into an offsetting derivative contract with a QCCP or when the clearing member banking organization provides a guarantee to the QCCP on the performance of the client for a derivative contract with the QCCP. Under the final rule, the agencies are clarifying that the MPOR is floored at five business days for derivative contracts subject to a variation margin agreement that are client-facing derivative transactions. For all other derivative contracts subject to a variation margin agreement, the MPOR is floored at ten business days. If over the previous two quarters a netting set is subject to two or more outstanding margin disputes that lasted longer than the MPOR, the applicable MPOR is twice the MPOR provided for those transactions in the absence of such disputes.106 For a derivative contract that is within a netting set that is composed of more than 5,000 derivative contracts that are not cleared transactions, or if a netting set contains one or more transactions involving illiquid collateral or a derivative contract that cannot be easily replaced, the MPOR is floored at 20 business days. For a cleared derivative contract in which on specified dates any outstanding exposure of the derivative contract is settled and the fair value of the derivative contract is reset to zero, the remaining maturity of the derivative contract is the period until the next reset date.107 In addition, derivative contracts with daily settlement would be treated as unmargined derivative contracts. However, as discussed in section III.D.4. of this SUPPLEMENTARY INFORMATION, a banking organization may elect to treat settled-to-market derivative contracts as collateralized-tomarket derivative contracts subject to a variation margin agreement and apply the maturity factor for derivative contracts subject to a variation margin agreement. 3. PFE Multiplier Under the proposal, the PFE multiplier would have recognized, if present, the amount of excess collateral available and the negative fair value of the derivative contracts within the netting set. Specifically, the PFE multiplier would have decreased exponentially from a value of one as the value of the financial collateral held exceeds the net fair value of the derivative contracts within the netting set, subject to a floor of 5 percent. This function accounted for the fact that the proposed aggregated amount formula would not have recognized financial collateral and would have assumed a zero market value for all derivative contracts. Several commenters argued that the PFE multiplier is too conservative and does not appropriately account for the risk-reducing effects of collateral. Some commenters argued that the calibration of the aggregated amount for a netting set would result in an overly conservative PFE multiplier amount, and that the aggregated amount in the PFE multiplier should be divided by at least two to mitigate such conservatism. Other commenters argued that because other factors under SA–CCR already contribute to the conservative recognition of initial margin (e.g., the calibration of the add-on, use of an exponential function, and reflection of collateral volatility through haircuts that do not allow any diversification across collateral), the agencies should decrease lotter on DSKBCFDHB2PROD with RULES2 PFE multiplier= min { 1; 0.05 the floor to 1 percent because initial margin requirements for uncleared swaps under the swap margin rule generally are calibrated to a 99 percent confidence level. Additionally, these commenters argued that the floor should not be a component of the PFE multiplier function but instead should act as an independent floor to the recognition of collateral under the PFE function. According to these comments, while these changes would result in more risk-sensitive initial margin recognition for heavily overcollateralized netting sets, the overall impact would remain conservative due to the overcalibration of the add-on. Other commenters asked the agencies to recognize the effect of collateral on a dollar-for-dollar basis, subject to haircuts, similar to the recognition of collateral under the replacement cost component of SA– CCR. Relative to CEM, SA–CCR is more sensitive to the risk-reducing benefits of collateral. However, the agencies recognize that as a standardized framework, SA–CCR may not appropriately capture risks in all cases (e.g., collateral haircuts may be less than those realized in stress periods) and therefore believe it is appropriate to instill conservatism. The combination of the exponential function and the floor provides adequate recognition of collateral while maintaining a sufficient level of conservatism by limiting decreases in PFE due to large amounts of collateral and preventing PFE from reaching zero for any amount of margin. This ensures that some amount of capital will be maintained even in situations where the transaction is overcollateralized. The commenters’ recommendations could, in certain circumstances, undermine these objectives. Therefore, the final rule adopts the PFE multiplier as proposed. Under the final rule, a banking organization must calculate the PFE multiplier using the formula set forth in §l.132(c)(7)(i) of the final rule, as follows: + 0.95 * e(;;*~)}, Where: V is the sum of the fair values (after excluding any valuation adjustments) of the derivative contracts within the netting set; 106 In general, a party will not have violated its obligation to collect or post variation margin from or to a counterparty if: The counterparty has refused or otherwise failed to provide or accept the required variation margin to or from the party; and the party has made the necessary efforts to collect or post the required variation margin, including the timely initiation and continued pursuit of formal dispute resolution mechanisms; or has otherwise demonstrated that it has made appropriate efforts to collect or post the required variation margin; or commenced termination of the derivative contract with the counterparty promptly following the applicable cure period and notification requirements. 107 See 12 CFR 3.2 (OCC); 12 CFR 217.2 (Board); and 12 CFR 324.2 (FDIC). VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 PO 00000 Frm 00028 Fmt 4701 Sfmt 4702 E:\FR\FM\24JAR2.SGM 24JAR2 ER24JA20.010</GPH> . Maturity factor ER24JA20.009</GPH> 4388 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations C is the sum of the net independent collateral amount and the variation margin amount applicable to the derivative contracts within the netting set; and A is the aggregated amount of the netting set. The PFE multiplier decreases as the net fair value of the derivative contracts within the netting set less the amount of collateral decreases below zero. Specifically, when the component V¥ C is greater than zero, the multiplier is equal to one. When the component V¥ C is less than zero, the multiplier is equal to an amount less than one and decreases exponentially in value as the absolute value of V¥ C increases. The PFE multiplier approaches a floor of 5 percent as the absolute value of V¥ C becomes very large as compared with the aggregated amount of the netting set. lotter on DSKBCFDHB2PROD with RULES2 4. PFE Calculation for Nonstandard Margin Agreements When a single variation margin agreement covers multiple netting sets, the parties exchange variation margin based on the aggregated market value of the netting sets—i.e., netting sets with positive and negative market values can offset one another to reduce the amount of variation margin that the parties are required to exchange. This can result, however, in a situation in which margin exchanged between the parties will be insufficient relative to the banking organization’s exposure amount for the netting sets.108 To address such a situation, the proposal would have required a banking organization to assign a single PFE to each netting set covered by a single variation margin agreement, calculated as if none of the derivative contracts within the netting set are subject to a variation margin agreement. The agencies did not receive comments on this aspect of the proposal, and are adopting it as proposed under § l.132(c)(10)(ii) of the final rule. The proposal also would have provided a separate calculation to determine PFE for a situation in which a netting set is subject to more than one variation margin agreement, or for a hybrid netting set. Under the proposal, 108 For example, consider a variation margin agreement with a zero threshold amount that covers two separate netting sets, one with a positive market value of 100 and the other with a market value of negative 100. The aggregate market value of the netting sets would be zero and thus no variation margin would be exchanged. However, the banking organization’s aggregate exposure amount for these netting sets would be equal to 100 because the negative market value of the second netting set would not be available to offset the positive market value of the first netting set. In the event of default of the counterparty, the banking organization would pay the counterparty 100 for the second netting set and would be exposed to a loss of 100 on the first netting set. VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 a banking organization would have divided the netting set into sub-netting sets and calculated the aggregated amount for each sub-netting set. In particular, all derivative contracts within the netting set that are not subject to a variation margin agreement or that are subject to a variation margin agreement under which the counterparty is not required to post variation margin would have formed a single sub-netting set. A banking organization would have been required to calculate the aggregated amount for this sub-netting set as if the netting set were not subject to a variation margin agreement. All derivative contracts within the netting set that are subject to variation margin agreements under which the counterparty must post variation margin and that share the same MPOR value would have formed another sub-netting set. A banking organization would have been required to calculate the aggregated amount for this sub-netting set as if the netting set were subject to a variation margin agreement, using the MPOR value shared by the derivative contracts within the netting set. Several commenters asked the agencies to allow banking organizations to net based solely on whether a QMNA that provides for closeout netting per applicable law in the event of default is in place. These commenters asserted that netting should not be limited to derivative contracts with the same MPOR because the purpose of the MPOR is to capture the risks associated with an extended closeout period upon a counterparty’s default and that differences in MPOR are unrelated to the legal ability to net upon closeout, which should be based only on legal certainty which is established under U.S. law if the netting agreement is a QMNA. In particular, commenters were concerned that the proposal would prohibit banking organizations from being able to net settled-to-market 109 derivative contracts with collateralizedto-market derivative contracts,110 as well as futures-style options and options with equity-style margining,111 even if 109 See supra note 18. general, in a collateralized-to-market derivative contract, title of transferred collateral stays with the posting party. 111 In general, for margining for options, the buyer of the option pays a premium upfront to the seller and there is no exchange of variation margin. The buyer, however, may credit the net value of the option against its initial margin requirements. The seller, in turn, receives a debit against its initial margin requirement in the amount of the net option value. The option is subject to daily revaluation with increases and decreases to the net option value resulting in adjustments to the buyer’s and the seller’s net option value credits and debits. In 4389 such contracts are within the same netting set. The proposal’s distinction between margined and unmargined derivative contracts would not have fully captured the relationship between settled-tomarket derivative contracts and collateralized-to-market derivative contracts that are cleared transactions as defined under § l.2 of the capital rule. In particular, under both cleared settledto-market and cleared collateralized-tomarket derivative transactions a banking organization must either make a settlement payment or exchange collateral to support its outstanding credit obligation to the counterparty on a periodic basis. Such contracts are functionally and economically similar from a credit risk perspective, and therefore, the final rule allows a banking organization to elect, at the netting set level, to treat all the settled-to-market derivative contracts within the netting set that are cleared transactions as subject to a variation margin agreement and receive the benefits of netting with cleared collateralized-to-market derivative contracts. That is, a banking organization that makes such election will treat such cleared settled-to-market derivative contracts as cleared collateralized-to-market derivative contracts, using the higher maturity factor applicable to collateralized-tomarket derivative contracts.112 Similarly, for listed options, the agencies are clarifying that a banking organization may elect to treat listed options on securities or listed options on futures with equity-style margining that are cleared transactions as margined derivatives. Under the final rule, a banking organization may elect to treat all such transactions within the same netting set as being subject to a variation margin agreement with a zero threshold amount and a zero minimum transfer amount, given that the daily net option value credits and debits are economically equivalent to an exchange of variation margin under a zero threshold and a zero minimum transfer amount. Consistent with the treatment described above for settled-to-market derivative contracts that are treated as collateralized-to-market, a banking 110 In PO 00000 Frm 00029 Fmt 4701 Sfmt 4702 addition, under U.S. GAAP, the option is an asset and the banking organization could use it in the event of a client’s default to offset any other losses the buyer may have. 112 § l.132(c)(9)(iv)(A) of the final rule. Similar to the treatment under CEM, SA–CCR provides a lower maturity factor for cleared settled-to-market derivative contracts that meet certain criteria. See ‘‘Regulatory Capital Treatment of Certain Centrallycleared Derivative Contracts Under Regulatory Capital Rules’’ (August 14, 2017), OCC Bulletin: 2017–27; Board SR letter 07–17; and FDIC Letter FIL–33–2017. E:\FR\FM\24JAR2.SGM 24JAR2 4390 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations organization that elects to apply this treatment must apply the maturity factor applicable to margined derivative contracts. Except for the changes described above, the agencies are adopting the proposed approach for netting sets subject to more than one variation margin agreement, or for a hybrid netting set.113 IV. Revisions to the Cleared Transactions Framework Under the capital rule, a banking organization must maintain regulatory capital for its exposure to, and certain collateral posted in connection with, a derivative contract that is a cleared transaction (as defined under § l.2 of the capital rule). A clearing member banking organization also must hold risk-based capital for its default fund contributions.114 The proposal would have revised the cleared transactions framework under the capital rule by replacing CEM with SA–CCR for advanced approaches banking organizations in both the advanced approaches and standardized approach. Non-advanced approaches banking organizations would have been permitted to elect to use SA–CCR or CEM for noncleared and cleared derivative contracts, but would have been required to use the same approach for both.115 In addition, the proposal would have simplified the formula that a clearing member banking organization 113 § l.132(c)(11)(ii) of the final rule. default fund contribution means the funds contributed or commitments made by a clearing member banking organization to a CCP’s mutualized loss-sharing arrangement. See 12 CFR 3.2 (OCC); 12 CFR 217.2 (Board); and 12 CFR 324.2, (FDIC). 115 At the time of the proposal, an advanced approaches banking organization meant a banking organization that has at least $250 billion in total consolidated assets or if it has consolidated onbalance sheet foreign exposures of at least $10 billion, or if it is a subsidiary of a depository institution, bank holding company, savings and loan holding company or intermediate holding company that is an advanced approaches banking organization. Under the tailoring proposals adopted by the agencies, the supplementary leverage ratio also would have applied to banking organizations subject to Category III. Banking organizations subject to Category III standards would have been permitted to use CEM or a modified version of SA– CCR for purposes of the supplementary leverage ratio, but consistent with the proposal to implement SA–CCR, they would have been required to use the same approach (CEM or SA–CCR) for all purposes under the capital rule. See ‘‘Proposed Changes to the Applicability Thresholds for Regulatory Capital and Liquidity Requirements,’’ 83 FR 66024 (December 21, 2018) and ‘‘Changes to Applicability Thresholds for Regulatory Capital Requirements for Certain U.S. Subsidiaries of Foreign Banking Organizations and Application of Liquidity Requirements to Foreign Banking Organizations, Certain U.S. Depository Instititution Holding Companies, and Certain Depository Institution Subsidiaries,’’ 84 FR 24296 (May 24, 2019). lotter on DSKBCFDHB2PROD with RULES2 114 A VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 must use to determine the risk-weighted asset amount for its default fund contributions. The proposed revisions were consistent with standards developed by the Basel Committee.116 A. Trade Exposure Amount Under the proposal, an advanced approaches banking organization that elected to use SA–CCR for purposes of determining the exposure amount of a noncleared derivative contract under the advanced approaches would have been required to also use SA–CCR (instead of IMM) to determine the trade exposure amount for a cleared derivative contract under the advanced approaches. In addition, an advanced approaches banking organization would have been required to use SA–CCR to determine the exposure amount for both its cleared and noncleared derivative contracts under the standardized approach. A non-advanced approaches banking organization that elected to use SA–CCR for purposes of determining the exposure amount of a non-cleared derivative contract would have been required to use SA–CCR (instead of CEM) to determine the trade exposure amount for a cleared derivative contract. Several commenters recommended providing advanced approaches banking organizations the option to use SA–CCR or IMM for purposes of the cleared transactions framework, regardless of the banking organization’s election to use SA–CCR or IMM to determine the exposure amount of noncleared derivative contracts under the advanced approaches. As discussed in section II.A. of this SUPPLEMENTARY INFORMATION, the agencies believe that requiring an advanced approaches banking organization to use one of either SA–CCR or IMM for both cleared and noncleared derivative contracts under the advanced approaches promotes consistency in the regulatory capital treatment of derivative contracts and facilitates the supervisory assessment of a banking organization’s capital management program. Some commenters asked the agencies to remove from the calculation of trade exposure amount the requirement to include non-cash initial margin posted to a CCP that is not held in a bankruptcy-remote manner. According to commenters, this requirement would overstate the banking organization’s exposure to such collateral, because collateral posted to a CCP remains on the balance sheet of the banking 116 See ‘‘Capital requirements for bank exposures to central counterparties,’’ Basel Committee on Banking Supervision (April 2014), https:// www.bis.org/publ/bcbs282.pdf. PO 00000 Frm 00030 Fmt 4701 Sfmt 4702 organization and must be reflected in risk-weighted assets under the capital rule. Collateral held in a manner that is not bankruptcy remote exposes a banking organization to risk of loss should the CCP fail and the banking organization is unable to recover its collateral. This counterparty credit risk is separate from, and in addition to, the risk inherent to the collateral itself. Thus, the final rule does not remove from the calculation of trade exposure amount the requirement to include noncash initial margin posted to a CCP that is not held in a bankruptcy remote manner. Other commenters asked for clarification regarding the scope of transactions that would be subject to the cleared transactions framework. In particular, the commenters asked the agencies to clarify the treatment of an exposure between a banking organization and a clearing member where the banking organization acts as agent for its client for a cleared transaction by providing a guarantee to the clearing member of the QCCP for the performance of the client. The final rule clarifies that, in such a situation, the banking organization may treat its exposure to the transaction as if the banking organization were the clearing member and directly facing the QCCP (i.e., the banking organization would have no exposure to the clearing member or the QCCP as long as it does not provide a guarantee to the client on the performance of the clearing member or QCCP).117 Furthermore, in such a situation, the banking organization may treat the exposure resulting from the guarantee of the client’s performance obligations with respect to the underlying derivative contract as a client-facing derivative transaction.118 Similarly, under CEM, the banking organization may adjust the exposure amount for the client-facing derivative transaction by applying a scaling factor of the square root of 1⁄2 (which equals 0.707107) to such exposure or higher if the banking organization determines a longer holding period is appropriate.119 Some commenters asked the agencies to clarify how a clearing member banking organization that acts as agent on behalf of a client should reflect its temporary exposure to the client for the 117 See 12 CFR 3.3(a) (OCC); 12 CFR 217.3(a) (Board); and 12 CFR 324.3(a) (FDIC). 118 As described in section III.D.2.d. of this SUPPLEMENTARY INFORMATION, for the client-facing derivative transaction (i.e., the banking organization’s exposure to the client due to the guarantee), the banking organization would treat the exposure as a non-cleared derivative contract using the five-business-day minimum MPOR. 119 See 12 CFR 3.34(e) (OCC); 12 CFR 217.34(e) (Board); and 12 CFR 324.34(e) (FDIC). E:\FR\FM\24JAR2.SGM 24JAR2 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations lotter on DSKBCFDHB2PROD with RULES2 collateral posted by the clearing member banking organization to the CCP, which the client subsequently will post to the clearing member banking organization. The commenters stated that the collateral advanced by the clearing member banking organization on behalf of the client creates a receivable under U.S. GAAP until the clearing member banking organization receives the collateral from the client. Accordingly, the commenters sought clarification on whether the amount of such receivables should be reflected in exposure amount of the client-facing derivative transaction or treated as a separate exposure to the client. Such receivables expose the clearing member banking organization to risk of loss should the client fail to subsequently post the collateral to the clearing member banking organization. This credit risk is separate from, and in addition to, the counterparty credit risk of the exposure arising from the client-facing derivative transaction, which represents the guarantee the clearing member banking organization provides for the client’s performance on the underlying derivative transaction. Thus, consistent with U.S. GAAP, a clearing member banking organization must treat such a receivable as a credit exposure to the client for purposes of the capital rule, separate from the treatment applicable to the client-facing derivative transaction under this final rule. For the reasons discussed above, the agencies are adopting as final under § l.133(b) of the final rule the proposal to replace CEM with SA–CCR for advanced approaches banking organizations in the capital rule, with one modification to introduce the defined term ‘‘client-facing derivative transactions’’ and clarify that such exposures receive a five-business-day minimum MPOR under SA–CCR, as discussed above. An advanced approaches banking organization that elects to use SA–CCR for purposes of determining the exposure amount of its noncleared derivative contracts under the advanced approaches must also use SA–CCR (instead of IMM) to determine the trade exposure amount for its cleared derivative contracts under the advanced approaches.120 A non-advanced approaches banking organization may continue to use CEM to determine the trade exposure amount for its cleared derivative contracts under 120 As discussed in section II.A. of this an advanced approaches banking organization must use SA–CCR to determine the trade exposure amount for its cleared derivative contracts and the exposure amount for its noncleared derivative contracts under the standardized approach. SUPPLEMENTARY INFORMATION, VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 the standardized approach. However, a non-advanced approaches banking organization that elects to use SA–CCR to calculate the exposure amount for its noncleared derivative contracts must use SA–CCR to calculate the trade exposure amount for its cleared derivative contracts. B. Treatment of Default Fund Contributions The proposal would have revised certain of the approaches that a banking organization could use to determine the risk-weighted asset amount for its default fund contributions. Specifically, the proposal would have eliminated method one and method two under section 133(d)(3) of the capital rule, either of which may be used by a clearing member banking organization to determine the risk-weighted asset amount for its default fund contributions to a QCCP.121 In its place, the proposal would have implemented a single approach for a clearing member banking organization to determine the risk-weighted asset amount for its default fund contributions to a QCCP, which would have been less complex than method one but also more granular than method two. The proposal would have maintained the approach by which a clearing member banking organization determines its risk-weighted asset amount for its default fund contributions to a CCP that is not a QCCP.122 Some commenters asked the agencies to clarify that a banking organization’s commitment to enter into reverse repurchase agreements with a CCP are not default fund contributions. Certain CCPs may require clearing members to provide funding in the form of reverse repurchase agreements in the event of a clearing member’s default in order to support the liquidity needs of the CCP. The capital rule defines default fund contributions as the funds contributed to or commitments made by a clearing member to a CCP’s mutualized loss sharing arrangements. The proposal did not contemplate changes to the definition of default fund contributions and the final rule does not revise this 121 Method one is a complex three-step approach that compares the default fund of the QCCP to the capital the QCCP would be required to hold if it were a banking organization and provides a method to allocate the default fund deficit or excess back to the clearing member. Method two is a simplified approach in which the risk-weighted asset amount for a default fund contribution to a QCCP equals 1,250 percent multiplied by the default fund contribution, subject to a cap. 122 In that case, the risk-weighted asset amount is the sum of the clearing member banking organization’s default fund contributions multiplied by 1,250 percent. PO 00000 Frm 00031 Fmt 4701 Sfmt 4702 4391 definition. Whether or not a particular arrangement meets the definition in the regulation depends on the facts and circumstances of the particular arrangement. The agencies may consider whether revisions to the definition are necessary in connection with future rulemakings if the definition is not functioning as intended. Other commenters asked the Board to revise Regulation HH 123 to require QCCPs regulated by the Board to make available to clearing member banking organizations the information required to calculate the QCCP’s hypothetical capital requirement. The commenters raised concerns that while domestic QCCPs will likely be prepared to provide the requisite data to calculate the hypothetical capital requirement, no regulation requires them to do so, and that foreign QCCPs are not subject to U.S. regulation and may not be prepared to provide the requisite data. The commenters also encouraged the agencies to work with the SEC and the CFTC to make similar revisions to their regulations applicable to domestic QCCPs and with international standard setters and foreign regulators to ensure that foreign QCCPs will be capable of providing U.S. banking organizations with the data required for the hypothetical capital calculations under the proposal. Lastly, the commenters asked that the agencies clarify that banking organizations may rely on the amount of a foreign QCCP’s hypothetical capital requirement produced under a Basel-compliant SA– CCR regime. The proposal did not contemplate changes to Regulation HH and thus the agencies view these comments as out of scope for this rulemaking. In addition, the Board’s Regulation HH serves a different purpose than the capital rule and covers a different set of entities. However, the agencies recognize the concerns raised by the commenters with respect to potential difficulties for banking organizations in calculating the hypothetical capital requirement of a QCCP and intend to monitor whether banking organizations experience difficulties obtaining the hypothetical capital requirement (or the requisite information required to calculated it) from the QCCP to perform this calculation.124 In recognition of these 123 See 12 CFR part 234. Regulation HH relates to the regulation of designated financial market utilities by the Board. 124 Under the capital rule, if a CCP does not provide the hypothetical capital requirement (or, alternatively, the required data) the CCP is not a QCCP and a banking organization must apply a risk weight of 1250 percent to its default fund E:\FR\FM\24JAR2.SGM Continued 24JAR2 4392 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations lotter on DSKBCFDHB2PROD with RULES2 concerns, the final rule allows banking organizations that elect to use SA–CCR to continue to use method 1 or method 2 under CEM to calculate the riskweighted asset amount for default fund contributions until January 1, 2022.125 This is intended to provide sufficient time for clearing member banking organizations to coordinate with CCPs to obtain the hypothetical capital requirement produced under SA–CCR (or the requisite information to calculate it) from the CCPs, in order for such entities to qualify as QCCPs after the mandatory compliance date. The agencies are also clarifying that after January 1, 2022, the mandatory compliance date, a banking organization that is using SA–CCR may only consider a foreign CCP to be a QCCP for purposes of the capital rule if the foreign CCP produces its hypothetical capital requirement under SA–CCR (as implemented by the CCP’s home country in a manner consistent with the Basel Committee standard). The agencies intend to monitor whether banking organizations experience difficulties obtaining the hypothetical capital requirement (or alternatively, the required data) after the January 1, 2022, mandatory compliance date. If, after January 2022, significant obstacles remain after a banking organization has made best efforts to obtain the necessary information from CCPs (e.g., due to delays in the implementation of the Basel Committee standard in other jurisdictions), its primary Federal regulator may permit the banking organization to use method 2 of CEM to calculate risk-weighted asset amounts for default fund contributions for a specified period. The agencies otherwise are generally adopting without change the proposed revisions to the risk-weighted asset calculation for default fund contributions under § l.133(d) of the final rule.126 Thus, to determine the capital requirement for a default fund contributions to the CCP. See definition of ‘‘qualifying central counterparty’’ under § l.2 of the capital rule, 12 CFR 3.2 (OCC); 12 CFR 217.2 (Board); and 12 CFR 324.2 (FDIC). 125 In cases where a banking organization uses method 1 to calculate the risk-weighted asset amount for a default fund contribution, a QCCP that provides the banking organization its hypothetical capital requirement produced using CEM would still qualify as a QCCP until January 1, 2022. 126 In a nonsubstantive change, the agencies moved paragraphs (i) and (ii) of § l.133(d)(3) of the proposed rule text to paragraphs (iv) and (v) under § l.133(d)(6) of the final rule text. The agencies made this change because these sections provide instruction on calculating EAD for default fund contribution accounts, which are covered under § l.133(d)(6). In addition, the agencies changed the reference to (e)(4) in § l.133(d)(3) of the proposed rule text to (d)(4). VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 contribution to a QCCP, a clearing member banking organization first calculates the hypothetical capital requirement of the QCCP (KCCP), unless the QCCP has already disclosed it, in which case the banking organization must rely on that disclosed figure. In either case, a banking organization may choose to use a higher amount of KCCP than the minimum calculated under the formula or disclosed by the QCCP if the banking organization has concerns about the nature, structure, or characteristics of the QCCP. In effect, KCCP serves as a consistent measure of a QCCP’s default fund amount. Under the final rule, a clearing member banking organization must calculate KCCP according to the following formula: KCCP = SCMi EADi * 1.6 percent, Where: CMi is each clearing member of the QCCP; and EADi is the exposure amount of the QCCP to each clearing member of the QCCP, as determined under § l.133(d)(6).127 The component EADi includes both the clearing member banking organization’s own transactions, the client transactions guaranteed by the clearing member, and all values of collateral held by the QCCP (including the clearing member banking organization’s pre-funded default fund contribution) against these transactions. The 1.6 percent amount represents the product of a capital ratio of 8 percent and a 20 percent risk weight of a clearing member banking organization. Subject to the transitional provisions described above, as of January 1, 2022, a banking organization that is required or elects to use SA–CCR to determine the exposure amount for its derivative contracts under the standardized approach must use a KCCP calculated using SA–CCR for both the standardized approach and the advanced approaches.128 For purposes of 127 Section 133(d)(6) of the proposed rule text would have required a banking organization to sum the exposure amount of all underlying transactions, the collateral held by the CCP, and any prefunded default contributions. In a technical correction to the proposal, and to recognize that collateral held by the QCCP and any prefunded default fund contributions serve to mitigate this exposure, the final rule text at section 133(d)(6) clarifies that banking organizations under the final rule must subtract from the exposure amount the value of collateral held by the QCCP and any prefunded default contributions. The final rule is consistent with the Basel Committee standard regarding capital requirements for bank exposures to central counterparties. See supra note 116. 128 The final rule does not revise the calculations for determining the exposure amount of repo-style transactions for purposes of determining the riskweighted asset amount of a banking organization’s default fund contributions. PO 00000 Frm 00032 Fmt 4701 Sfmt 4702 calculating KCCP, the PFE multiplier includes collateral held by a QCCP in which the QCCP has a legal claim in the event of the default of the member or client, including default fund contributions of that member. In addition, the QCCP must use a MPOR of ten business days in the maturity factor adjustment. A banking organization that elects to use CEM to determine the exposure amount of its derivative contracts under the standardized approach must use a KCCP calculated using CEM. EAD must be calculated separately for each clearing member banking organization’s sub-client accounts and sub-house account (i.e., for the clearing member’s proprietary activities). If the clearing member banking organization’s collateral and its client’s collateral are held in the same account, then the EAD of that account would be the sum of the EAD for the client-related transactions within the account and the EAD of the house-related transactions within the account. In such a case, for purposes of determining such EADs, the independent collateral of the clearing member banking organization and its client must be allocated in proportion to the respective total amount of independent collateral posted by the clearing member banking organization to the QCCP. This treatment protects against a clearing member banking organization recognizing client collateral to offset the QCCP’s exposures to the clearing member banking organization’s proprietary activity in the calculation of KCCP. In addition, if any account or subaccount contains both derivative contracts and repo-style transactions, the EAD of that account is the sum of the EAD for the derivative contracts within the account and the EAD of the repo-style transactions within the account. If independent collateral is held for an account containing both derivative contracts and repo-style transactions, then such collateral must be allocated to the derivative contracts and repo-style transactions in proportion to the respective productspecific exposure amounts. The respective product specific exposure amounts must be calculated, excluding the effects of collateral, according to § l.132(b) of the capital rule for repostyle transactions and to § l.132(c)(5) for derivative contracts. A clearing member banking organization also must calculate its capital requirement (KCMi), which is the capital requirement for its default fund contribution, subject to a floor equal to a 2 percent risk weight multiplied by the clearing member banking E:\FR\FM\24JAR2.SGM 24JAR2 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations KeM•i ) = max ( Keep * ( DF DFpref +DFpre1 CCP Where: KCCP is the hypothetical capital requirement of the QCCP; DFpref is the prefunded default fund contribution of the clearing member banking organization to the QCCP; DFCCP is the QCCP’s own prefunded amounts (e.g., contributed capital, retained earnings) that are contributed to the default fund waterfall and are junior or pari passu to the default fund contribution of the members; and DFCMpref is the total prefunded default fund contributions from clearing members of the QCCP. lotter on DSKBCFDHB2PROD with RULES2 requirement increases as its contribution to the default fund increases relative to the QCCP’s own prefunded amounts and the total prefunded default fund contributions from all clearing members to the QCCP. In all cases, a clearing member banking organization’s capital requirement for its CM · 0.16% ' default fund contribution to a QCCP may not exceed the capital requirement that would apply if the same exposure were calculated as if it were to a CCP that is not a QCCP. A clearing member banking organization calculates according to the following formula: 129 * DFpref ) ' V. Revisions to the Supplementary Leverage Ratio Under the capital rule, advanced approaches banking organizations and banking organizations subject to Category III standards must satisfy a minimum supplementary leverage ratio requirement of 3 percent.130 The supplementary leverage ratio is the ratio of tier 1 capital to total leverage exposure, where total leverage exposure includes both on-balance sheet assets and certain off-balance sheet exposures.131 The proposal would have revised the capital rule to require advanced approaches banking organizations to use a modified version of SA–CCR, instead of CEM, to determine the on- and offbalance sheet amounts of derivative contracts for purposes of calculating total leverage exposure. The modified version of SA–CCR would have limited the recognition of collateral to certain cash variation margin 132 in the replacement cost calculation, but would not have allowed for recognition of any financial collateral in the PFE component.133 The proposal sought comment on whether the agencies should broaden the recognition of collateral in the supplementary leverage ratio to also include collateral provided by a client to a clearing member banking organization in connection with a cleared transaction (client collateral), in recognition of recent policy efforts to support migration of derivative transactions to CCPs, including an October 2018 consultative release by the Basel Committee on the treatment of client collateral in the international leverage ratio standard.134 Several commenters urged the agencies to recognize greater amounts of client collateral, including margin, in either PFE or in both replacement cost and PFE. Other commenters, however, argued that the agencies should not recognize greater amounts of client collateral, including cash or non-cash initial and variation margin, in connection with cleared transactions entered into on behalf of clients or any amount of margin collateral within the supplementary leverage ratio. In addition, some commenters urged the agencies to assess the effectiveness of collateral in offsetting the operational risks arising from the provision of client clearing services. Commenters that supported greater recognition of client collateral argued that such an approach would be consistent with the G20 mandate to establish policies that support the use of central clearing for derivative transactions,135 as it could decrease the regulatory capital cost of providing clearing services and thereby improve access to clearing services for clients, reduce concentration among clearing member banking organizations, and improve the portability of client positions to other clearing members, particularly in times of stress. Other commenters argued that allowing an advanced approaches banking organization to use the same SA–CCR methodology as proposed for the riskbased framework would simplify the capital rule for advanced approaches banking organizations. Some commenters urged the agencies to consider the risk to financial stability if implementation of SA–CCR further exacerbates the trend towards concentration among clearing service providers or leads to a reduction in access to clearing for non-clearingmember entities. Of these, some commenters also argued that the proposed SA–CCR methodology could 129 The agencies are clarifying that K CMi must be multiplied by 12.5 to arrive at the risk-weighted asset amount for a default fund contribution. 130 See 12 CFR 3.10(a)(5) (OCC); 12 CFR 217.10(a)(5) (Board); and 12 CFR 324.10(a)(5) (FDIC). 131 See supra note 6. 132 Consistent with CEM, the proposal would have permitted an advanced approaches banking organization to recognize cash variation margin in the on-balance component calculation only if (1) the cash variation margin met the conditions under § l.10(c)(4)(ii)(C)(3) through (7) of the proposed rule; and (2) it had not been recognized in the form of a reduction in the fair value of the derivative contracts within the netting set under the advanced approaches banking organization’s operative accounting standard. 133 To determine the carrying value of derivative contracts, U.S. GAAP provides a banking organization with the option to reduce any positive fair value of a derivative contract by the amount of any cash collateral received from the counterparty, provided the relevant GAAP criteria for offsetting are met (the GAAP offset option). Similarly, under the GAAP offset option, a banking organization has the option to offset the negative mark-to-fair value of a derivative contract with a counterparty. See Accounting Standards Codification paragraphs 815– 10–45–1 through 7 and 210–20–45–1. Under the capital rule, a banking organization that applies the GAAP offset option to determine the carrying value of its derivative contracts would be required to reverse the effect of the GAAP offset option for purposes of determining total leverage exposure, unless the collateral is cash variation margin recognized as settled with the derivative contract as a single unit of account for balance sheet presentation and satisfies the conditions under § l.10(c)(4)(ii)(C)(1)(ii) through (iii) and § l.10(c)(4)(ii)(C)(3) through (7) of the capital rule. 134 See ‘‘Consultative Document: Leverage ratio treatment of client cleared derivatives,’’ Basel Committee on Banking Supervision (October 2018), https://www.bis.org/bcbs/publ/d451.pdf. 135 The Group of Twenty (G20) was established in 1999 to bring together industrialized and developing economies to discuss key issues in the global economy. Members include finance ministers and central bank governors from Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia, South Africa, Republic of Korea, Turkey, the United Kingdom, and the United States and the European Union. See ‘‘Leaders’ Statement: The Pittsburgh Summit,’’ G–20 (September 24–25, 2009), https://www.treasury.gov/resource-center/ international/g7-g20/Documents/pittsburgh_ summit_leaders_statement_250909.pdf. VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 PO 00000 Frm 00033 Fmt 4701 Sfmt 4702 E:\FR\FM\24JAR2.SGM 24JAR2 ER24JA20.011</GPH> organization’s prefunded default fund contribution to the QCCP and an 8 percent capital ratio. This calculation allocates KCCP on a pro rata basis to each clearing member based on the clearing member’s share of the overall default fund contributions. Thus, a clearing member banking organization’s capital 4393 lotter on DSKBCFDHB2PROD with RULES2 4394 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations indirectly adversely affect clearing member clients with directional and long-dated portfolios, such as pension funds, mutual funds, life insurance companies and other end-users that use derivatives largely for risk management purposes. Specifically, these commenters argued that such entities have already experienced difficulty in obtaining and maintaining access to central clearing from banking organizations due to the treatment of client margin, which substantially increases the capital requirements under the supplementary leverage ratio for banking organizations that provide clearing services. Other commenters argued that limiting the recognition of client collateral in the supplementary leverage ratio could have pro-cyclical effects that undermine the core objectives of the clearing framework. These commenters asserted that CCPs typically increase collateral requirements during stress periods, and therefore can cause clearing member banking organizations to be bound, or further bound, by the supplementary leverage ratio during that time. According to the commenters, procyclicality in the capital requirements for a clearing member could undermine the client-account portability objective of the central clearing framework if the clearing member is unable to acquire a book of cleared derivatives from another failing clearing member due to the regulatory capital costs of such acquisition. Furthermore, some commenters posited that greater recognition of the risk-reducing effects of client collateral for purposes of the supplementary leverage ratio would be appropriate due to the manner in which clearing member banking organizations collect such collateral and the protections such collateral receives under existing regulations. Specifically, these commenters noted that CFTC regulations prohibit rehypothecation of client collateral, and explicitly limit a clearing member banking organization’s use of collateral received from a client to purposes that fulfil the clearing member’s obligations to the CCP or to cover losses in the event of that client’s default. By contrast, commenters who opposed greater recognition of the riskreducing effects of client collateral under the supplementary leverage ratio expressed concern that such an approach would decrease capital levels among clearing member banking organizations and therefore could increase risks to both safety and soundness and U.S. financial stability. In particular, some commenters noted VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 that solvency of clearing member banking organizations is critical to the stability of CCPs and that broadening the recognition of client collateral under the supplementary leverage ratio could undermine the advances made by central clearing mandates in stabilizing global financial markets. These commenters added that higher levels of regulatory capital at clearing member banking organizations could improve their ability to assume client positions from a defaulted clearing member in stress, and that the agencies have authority to provide temporary relief to leverage capital requirements if doing so would be necessary to allow a banking organization to absorb the client positions of an insolvent clearing member. With respect to concentration concerns, these commenters argued that lowering capital requirements for clearing member banking organizations would not reduce concentration in the provision of clearing services; rather, any further reduction in capital requirements for clearing member banking organizations would only benefit banking organizations that already provide these services. In addition, these commenters expressed concern regarding the introduction of risk mitigants into the leverage capital requirements, and stated that such a revision could blur the distinction between leverage and risk-based capital requirements. The final rule allows a clearing member banking organization to recognize the risk-reducing effect of client collateral in replacement cost and PFE for purposes of calculating total leverage exposure under certain circumstances.136 This treatment applies to a banking organization’s exposure to its client-facing derivative transactions. For such exposures, the banking organization would use SA– CCR, as applied for risk-based capital purposes, which permits recognition of both cash and non-cash margin received from a client in replacement cost and PFE. The agencies believe that this treatment appropriately recognizes recent developments in the use of central clearing and maintains levels of capital consistent with safe and sound operations of banking organizations engaged in these activities. Although there are some risks associated with CCPs, the agencies believe that central clearing through CCPs generally reduces the effective exposure of derivative contracts through the multilateral netting of exposures, establishment and 136 The recognition of client collateral provided under the final rule only applies in the context of SA–CCR, not CEM. PO 00000 Frm 00034 Fmt 4701 Sfmt 4702 enforcement of collateral requirements, and promotion of market transparency. Also, this treatment is consistent with the G20 mandate to establish policies that support the use of central clearing, and recent developments by the Basel Committee. Specifically, on June 26, 2019, the Basel Committee released a standard that revises the leverage ratio treatment of client-cleared derivatives contracts to generally align with the measurement of such exposures under SA–CCR as used for risk-based capital purposes.137 The standard was designed to balance the robustness of the supplementary leverage ratio as a nonrisk-based safeguard against unsustainable sources of leverage with the policy objective set by G20 leaders to promote central clearing of standardized derivative contracts as part of mitigating systemic risk and making derivative markets safer. The final rule similarly maintains the complementary purpose of risk-based and leverage capital requirements, in a manner that is expected to have minimal impact on overall capital levels, will reduce burden by reducing the number of separate calculations required, and will not impede important policy objectives regarding central clearing. Banking organizations subject to the supplementary leverage ratio under Category III that continue to use CEM to determine the total leverage exposure measure are not permitted to recognize the risk-reducing effects of client collateral other than with respect to certain transfers of cash variation margin in replacement cost. Relative to CEM, SA–CCR is more sensitive to the recognition of collateral, and therefore the commenters’ concerns are more pronounced in that context. Moreover, most clearing member banking organizations are advanced approaches banking organizations that are required to use SA–CCR or IMM for the cleared transactions framework, and extending such treatment to CEM would have limited impact, if any, in the aggregate. Some commenters noted that section 34 of the capital rule allows a banking organization subject to the supplementary leverage ratio to exclude the PFE of all credit derivatives or other similar instruments through which it provides credit protection, but without regard to credit risk mitigation, provided that it does not adjust the netto-gross ratio. Under the capital rule, a banking organization subject to the supplementary leverage ratio that chooses to exclude the PFE of credit derivatives or other similar instruments through which it provides credit 137 See E:\FR\FM\24JAR2.SGM supra note 20. 24JAR2 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations protection must do so consistently over time for the calculation of the PFE for all such instruments. The agencies are clarifying that the same treatment would apply under SA–CCR for purposes of the supplementary leverage ratio.138 In particular, a banking organization subject to the supplementary leverage ratio may choose to exclude from the PFE component of the exposure amount calculation the portion of a written credit derivative that is not offset according to § l.10(c)(4)(ii)(D)(1)–(2) and for which the effective notional amount of the written credit derivative is included in total leverage exposure. The agencies generally are adopting as final the proposed requirement that a banking organization that is required to use SA–CCR or elects to use SA–CCR to calculate the exposure amount of its derivative contracts for purposes of the supplementary leverage ratio must use the modified version of SA–CCR described in § l.10(c)(4)(ii) of the final rule, with a few revisions.139 For a client-facing derivative transaction, however, the banking organization calculates the exposure amount under § l.132(c)(5). Consistent with the proposal, written options must be included in total leverage exposure even though the final rule allows certain written options to receive an exposure amount of zero for risk-based capital purposes.140 VI. Technical Amendments lotter on DSKBCFDHB2PROD with RULES2 The proposal would have made several technical corrections and clarifications to the capital rule to address certain provisions that warrant revision based on questions presented 138 See 79 FR 57725, 57731–57732 (Sept. 26, 2014). 139 Some commenters requested clarification regarding the items to be summed under § l.10(c)(4)(ii)(C)(1) of the proposed rule. The agencies are clarifying that the items to be summed under this paragraph (now located at § l.10(c)(4)(ii)(C)(2)(i) of the final rule) are the replacement cost of each derivative contract or single product netting set of derivative contracts to which the advanced approaches banking organization is a counterparty, as described under 10(c)(4)(ii)(C)(2)(i) of the final rule. Section l.10(c)(4)(ii)(C)(2)(ii) of the final rule serves to adjust, under certain situations, the items to be summed under § l.10(c)(4)(ii)(C)(2)(i). In addition, these commenters requested clarification of the application of § l.10(c)(4)(ii)(C)(2) in the proposal. The agencies are removing § l.10(c)(4)(ii)(C)(2) from the final rule, as this provision is captured under the definition of the cash variation margin terms in the formula described under § l.10(c)(4)(ii)(C)(2)(i). 140 Under the final rule, the exposure amount of a netting set that consists of only sold options in which the premiums have been fully paid by the counterparty to the options and where the options are not subject to a variation margin agreement is zero. See section III.A. of this SUPPLEMENTARY INFORMATION for further discussion. VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 by banking organizations and further review by the agencies. The agencies did not receive comment on these technical amendments, and are finalizing them as proposed. The agencies did receive several suggestions for other clarifications and technical changes to the proposal. The agencies are adopting many of these suggestions in the final rule. These changes are described below. A. Receivables Due From a QCCP The final rule revises § l.32 of the capital rule to clarify that cash collateral posted by a clearing member banking organization to a QCCP, and which could be considered a receivable due from the QCCP under U.S. GAAP, should not be risk-weighted as a corporate exposure. Instead, for a clientcleared trade the cash collateral posted to a QCCP receives a risk weight of 2 percent, if the cash associated with the trade meets the requirements under § l.35(b)(3)(i)(A) or § l.133(b)(3)(i)(A) of the capital rule, or 4 percent, if the collateral does not meet the requirements necessary to receive the 2 percent risk weight. For a trade made on behalf of the clearing member’s own account, the cash collateral posted to a QCCP receives a 2 percent risk weight. The agencies intend for this amendment to maintain incentives for banking organizations to post cash collateral and recognize that a receivable from a QCCP that arises in the context of a trade exposure should not be treated as equivalent to a receivable that would arise if, for example, a banking organization made a loan to a CCP. B. Treatment of Client Financial Collateral Held by a CCP Under § l.2 of the capital rule, financial collateral means, in part, collateral in which a banking organization has a perfected firstpriority security interest in the collateral. However, when a banking organization is acting on behalf of a client, it generally is required to post any client collateral to the CCP, in which case the CCP establishes and maintains a perfected first-priority security interest in the collateral instead of the clearing member. As a result, the capital rule does not permit a clearing member banking organization to recognize client collateral posted to a CCP as financial collateral. Client collateral posted to a CCP remains available to mitigate the risk of a credit loss on a derivative contract in the event of a client default. Specifically, when a client defaults the CCP will use the client collateral to offset its exposure to the client, and the PO 00000 Frm 00035 Fmt 4701 Sfmt 4702 4395 clearing member banking organization would be required to cover only the amount of any deficiency between the liquidation value of the collateral and the CCP’s exposure to the client. However, were the clearing member banking organization to enter into the derivative contract directly with the client, the clearing member would establish and maintain a perfected firstpriority security interest in the collateral, and the exposure of the clearing member to the client would similarly be mitigated only to the extent the collateral is sufficient to cover the exposure amount of the transaction at the time of default. Therefore, the final rule revises the definition of financial collateral to allow clearing member banking organizations to recognize as financial collateral noncash client collateral posted to a CCP. In this situation, the clearing member banking organization is not required to establish and retain a first-priority security interest in the collateral for it to qualify as financial collateral under § l.2 of the capital rule. C. Clearing Member Exposure When CCP Performance Is Not Guaranteed The final rule revises § l.35(c)(3) of the capital rule to align the capital requirements under the standardized approach for client-cleared transactions with the treatment under § l.133(c)(3) of the advanced approaches. Specifically, the final rule allows a clearing member banking organization that does not guarantee the performance of the CCP to the clearing member’s client to apply a zero percent risk weight to the CCP-facing portion of the transaction. The agencies previously implemented this treatment for purposes of the advanced approaches.141 D. Bankruptcy Remoteness of Collateral The final rule removes the requirement in § l.35(b)(4)(i) of the standardized approach and § l.133(b)(4)(i) of the advanced approaches that collateral posted by a clearing member client banking organization to a clearing member banking organization must be bankruptcy remote from a custodian in order for the client banking organization to avoid the application of risk-based capital requirements related to the collateral, and clarifies that a custodian must be acting in its capacity as a custodian for this treatment to apply.142 141 See 80 FR 41411 (July 15, 2015). 12 CFR 3.35(b)(4) and 3.133(b)(4) (OCC); 12 CFR 217.35(b)(4) and 217.133(b)(4) (Board); and 12 CFR 324.35(b)(4) and 324.133(b)(4) (FDIC). 142 See E:\FR\FM\24JAR2.SGM 24JAR2 4396 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations lotter on DSKBCFDHB2PROD with RULES2 The agencies believe this revision is appropriate because the collateral would generally be considered to be bankruptcy remote if the custodian is acting in its capacity as a custodian with respect to the collateral. Therefore, this revision applies only in cases where the collateral is deposited with a third-party custodian, not in cases where a clearing member banking organization offers ‘‘self-custody’’ arrangements with its clients. In addition, this revision makes the collateral requirement for a clearing member client banking organization consistent with the treatment of collateral posted by a clearing member banking organization, which does not require that the posted collateral be bankruptcy remote from the custodian, but requires in each case that the custodian be acting in its capacity as a custodian. E. Adjusted Collateral Haircuts for Derivative Contracts For a cleared transaction, the clearing member banking organization must determine the exposure amount for the client-facing derivative transaction of the derivative contract using the collateralized transactions framework under § l.37(c)(3) of the capital rule or the counterparty credit risk framework under § l.132(b)(2)(ii) of the capital rule. The clearing member banking organization may recognize the credit risk-mitigation benefits of the collateral posted by the client; however, under §§ l.37(c) and l.132(b) of the capital rule, the value of the collateral must be discounted by the application of a standard supervisory haircut to reflect any market price volatility in the value of the collateral over a ten-business-day holding period. For a repo-style transaction, the capital rule applies a scaling factor of the square root of 1⁄2 (which equals 0.707107) to the standard supervisory haircuts to reflect the limited risk to collateral in those transactions and effectively reduce the holding period to five business days. The proposal would have provided a similar reduction in the haircuts for client-facing derivative transactions, as they typically have a holding period of less than ten business days. Some commenters requested clarification whether a five-business-day holding period would apply for the purpose of calculating collateral haircuts for clientfacing derivatives under § l.132(b)(2)(ii)(A)(3) of the proposal. The final rule revises §§ l.37(c)(3)(iii) and l.132(b)(2)(ii)(A)(3) of the capital rule to adjust the holding period for client-facing derivative transactions by applying a scaling factor of 0.71, which represents a five-business-day holding VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 period. The final rule also requires a banking organization to use a larger scaling factor for collateral haircuts for client-facing derivatives when it determines a holding period longer than five days is appropriate. F. OCC Revisions to Lending Limits The OCC proposed to revise its lending limit rule at 12 CFR part 32. The current lending limits rule references sections of CEM in the OCC’s advanced approaches capital rule as one available methodology for calculating exposures to derivatives transactions. However, these sections were proposed to be amended or replaced with SA–CCR in the advanced approaches. Therefore, the OCC proposed to replace the references to CEM in the advanced approaches with references to CEM in the standardized approach. The OCC also proposed to adopt SA–CCR as an option for calculation of exposures under lending limits. The agencies received two comments supporting the OCC’s proposal to use SA–CCR to measure counterparty credit risk under both the capital rules and other agency rules, including lending limits, as creating less burden on institutions. The OCC agrees that it would be less burdensome for institutions to use similar methodologies to measure counterparty credit risk across OCC regulations, and therefore are finalizing these revisions to the lending limits rule as proposed. G. Other Clarifications and Technical Amendments From the Proposal to the Final Rule Some commenters suggested that the agencies make a revision to the approaches for calculating capital requirements regarding CVAs under § l.132(e). Under the final rule, the agencies are clarifying that for purposes of calculating the CVA capital requirements under § l.132(e)(5)(i)(C), (e)(6)(i)(B) and (e)(6)(viii), an advanced approaches banking organization must use SA–CCR instead of CEM where CEM was provided as an option. In addition, the final rule revises the definition of CEM in § l.2 to refer to § l.34(b) instead of § l.34(a). VII. Impact of the Final Rule For the proposal, the agencies reviewed data provided by advanced approaches banking organizations that represent a significant majority of the derivatives market. In particular, the agencies analyzed the change in exposure amount between CEM and SA–CCR, as well as the change in riskweighted assets as determined under the PO 00000 Frm 00036 Fmt 4701 Sfmt 4702 standardized approach.143 The data cover diverse portfolios of derivative contracts, both in terms of asset type and counterparty. In addition, the data include firms that serve as clearing members, allowing the agencies to consider the effect of the proposal under the cleared transactions framework for both a direct exposure to a CCP and a clearing member’s exposure to its client with respect to client-facing derivative transactions. As a result, the analysis provides a reasonable proxy for the potential changes for all advanced approaches banking organizations. The agencies estimated that, under the proposal, the exposure amount for derivative contracts held by advanced approaches banking organizations would have decreased by approximately 7 percent. The agencies also estimated that the proposal would have resulted in an approximately 5 percent increase in advanced approaches banking organizations’ standardized riskweighted assets associated with derivative contract exposures.144 In addition, the proposal would have resulted in an increase (approximately 30 basis points) in advanced approaches banking organizations’ supplementary leverage ratios, on average. The agencies made several changes to the SA–CCR methodology for the final rule that could have a material effect on the impact of the final rule. First, the final rule changes certain of the supervisory factors for commodity derivative contracts to coincide with the supervisory factors in the Basel Committee standard.145 Second, the 143 The agencies estimated that, on aggregate, exposure amounts under SA–CCR would equal approximately 170 percent of the exposure amounts for identical derivative contracts under IMM. Thus, firms that use IMM currently would likely continue to use IMM to determine the exposure amount of their derivative contracts to determine advanced approaches total risk-weighted assets. However, the standardized approach serves as a floor on advanced approaches banking organizations’ total risk-weighted assets. Thus, a firm would only receive the benefit of IMM if the firm is not bound by standardized total risk-weighted assets. 144 Total risk-weighted assets are a function of the exposure amount of the netting set and the applicable risk-weight of the counterparty. Total risk-weighted assets increase under the analysis while exposure amounts decrease because higher applicable risk weights amplify increases in the exposure amount of certain derivative contracts, which outweighs decreases in the exposure amount of other derivative contracts. 145 The change in the supervisory factors for commodity derivative contracts will not result in a change in the agencies initial estimate of the impact of the final rule. This is because the data received from the advanced approach banking organizations already reflected the supervisory factors for commodity derivative contracts included in the Basel Standard, and the agencies did not adjust the data to account for the proposed 40 percent supervisory factor for all energy derivative contracts. E:\FR\FM\24JAR2.SGM 24JAR2 lotter on DSKBCFDHB2PROD with RULES2 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations final rule removes the alpha factor for exposures to commercial end-users. Third, the final rule allows a banking organization to treat settled-to-market derivative contracts as subject to a variation margin agreement, allowing such contracts to net with collateralized-to-market derivative contracts of the same netting set. Lastly, the final rule allows clearing member banking organizations to recognize client collateral under the supplementary leverage ratio, to the same extent a banking organization may recognize collateral for risk-based capital purposes. Using the same data set as used for the proposal, the agencies found that the exposure amount for derivative contracts held by advanced approaches banking organizations will decrease by approximately 9 percent under the final rule. Generally speaking, exposure amounts for interest rate, credit and foreign exchange derivatives would be expected to decrease, and exposure amounts for equities and commodities would be expected to increase. The agencies estimate that the final rule will result in an approximately 4 percent decrease in advanced approaches banking organizations’ standardized risk-weighted assets associated with derivative contract exposures and that the final rule will result in an increase (approximately 37 basis points) in advanced approaches banking organizations’ reported supplementary leverage ratios, on average. While too much precision should not be attached to estimates regarding individual banking organizations owing to variations in data quality, estimated changes in individual banking organizations’ supplementary leverage ratios range from ¥5 basis points to 85 basis points. In the proposal, the agencies found that the effects of the proposed rule likely would be limited for nonadvanced approaches banking organizations. First, these banking organizations hold relatively small derivative portfolios. Non-advanced approaches banking organizations account for less than 9 percent of derivative contracts of all banking organizations, even though they account for roughly 36 percent of total assets of all banking organizations.146 Second, nearly all non-advanced approaches banking organizations are not subject to supplementary leverage ratio requirements, and thus would not be 146 According to data from the Consolidated Reports of Condition and Income for a Bank with Domestic and Foreign Offices (FFIEC report forms 031, 041, and 051), as of March 31, 2018. VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 affected by any changes to the calculation of total leverage exposure. These banking organizations retain the option of using CEM, including for the supplementary leverage ratio, if applicable, and the agencies anticipate that only those banking organizations that receive a material net benefit from using SA–CCR would elect to use it. Therefore, the agencies continue to find that the impact on non-advanced approaches banking organizations under the final rule would be limited. VIII. Regulatory Analyses A. Paperwork Reduction Act The agencies’ regulatory capital rule contains ‘‘collections of information’’ within the meaning of the Paperwork Reduction Act (PRA) of 1995 (44 U.S.C. 3501–3521). In accordance with the requirements of the PRA, the agencies may not conduct or sponsor, and the respondent is not required to respond to, an information collection unless it displays a currently-valid Office of Management and Budget (OMB) control number. The OMB control number for the OCC is 1557–0318, Board is 7100– 0313, and FDIC is 3064–0153. The information collections that are part of the agencies’ regulatory capital rule will not be affected by this final rule and therefore no final submissions will be made by the FDIC or OCC to OMB under section 3507(d) of the PRA (44 U.S.C. 3507(d)) or section 1320.11 of the OMB’s implementing regulations (5 CFR 1320) in connection with this rulemaking.147 As a result of this final rule, the agencies have proposed to clarify the reporting instructions for the Consolidated Reports of Condition and 147 The OCC and FDIC submitted their information collections to OMB at the proposed rule stage. However, these submissions were done solely in an effort to apply a conforming methodology for calculating the burden estimates and not due to the proposed rule. OMB filed comments requesting that the agencies examine public comment in response to the proposed rule and describe in the supporting statement of its next collection any public comments received regarding the collection as well as why (or why it did not) incorporate the commenters’ recommendation. In addition, OMB requested that the OCC and the FDIC note the convergence of the agencies on the single methodology. The agencies received no comments on the information collection requirements. Since the proposed rule stage, the agencies have conformed their respective methodologies in a separate final rulemaking titled, ‘‘Regulatory Capital Rule: Implementation and Transition of the Current Expected Credit Losses Methodology for Allowances and Related Adjustments to the Regulatory Capital Rule and Conforming Amendments to Other Regulations,’’ 84 FR 4222 (February 14, 2019), and have had their submissions approved through OMB. As a result, the agencies information collections related to the regulatory capital rules are currently aligned and therefore no submission will be made to OMB. PO 00000 Frm 00037 Fmt 4701 Sfmt 4702 4397 Income (Call Reports) (FFIEC 031, FFIEC 041, and FFIEC 051) and Regulatory Capital Reporting for Institutions Subject to the Advanced Capital Adequacy Framework (FFIEC 101).148 The OCC and FDIC expect to clarify the reporting instructions for DFAST 14A, and the Board expects to clarify the reporting instructions for the Consolidated Financial Statements for Holding Companies (FR Y–9C), Capital Assessments and Stress Testing (FR Y– 14A and FR Y–14Q), and Banking Organization Systemic Risk Report (FR Y–15) as appropriate to reflect the changes to the regulatory capital rule related to this final rule. B. Regulatory Flexibility Act OCC: The Regulatory Flexibility Act, 5 U.S.C. 601 et seq. (RFA), requires an agency, in connection with a final rule, to prepare a Final Regulatory Flexibility Analysis describing the impact of the rule on small entities (defined by the Small Business Administration (SBA) for purposes of the RFA to include commercial banks and savings institutions with total assets of $600 million or less and trust companies with total revenue of $41.5 million or less) or to certify that the final rule would not have a significant economic impact on a substantial number of small entities. As of December 31, 2018, the OCC supervised 782 small entities. The rule would impose requirements on all OCC supervised entities that are subject to the advanced approaches risk-based capital rules, which typically have assets in excess of $250 billion, and therefore would not be small entities. While small entities would have the option to adopt SA–CCR, the OCC does not expect any small entities to elect that option. Therefore, the OCC estimates the final rule would not generate any costs for small entities. Therefore, the OCC certifies that the final rule would not have a significant economic impact on a substantial number of OCC-supervised small entities. FDIC: The RFA generally requires that, in connection with a final rulemaking, an agency prepare and make available for public comment a final regulatory flexibility analysis describing the impact of the rule on small entities.149 However, a regulatory flexibility analysis is not required if the agency certifies that the final rule will not have a significant economic impact on a substantial number of small entities. The SBA has defined ‘‘small entities’’ to include banking 148 See 149 5 E:\FR\FM\24JAR2.SGM 84 FR 53227 (October 4, 2019). U.S.C. 601 et seq. 24JAR2 4398 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations organizations with total assets of less than or equal to $600 million that are independently owned and operated or owned by a holding company with less than or equal to $600 million in total assets.150 Generally, the FDIC considers a significant effect to be a quantified effect in excess of 5 percent of total annual salaries and benefits per institution, or 2.5 percent of total noninterest expenses. The FDIC believes that effects in excess of these thresholds typically represent significant effects for FDIC-supervised institutions. For the reasons described below, the FDIC believes that the final rule will not have a significant economic impact on a substantial number of small entities. Nevertheless, the FDIC has conducted and is providing a final regulatory flexibility analysis. 1. The Need for, and Objectives of, the Rule The policy objective of the final rule is to provide a new and more risksensitive methodology for calculating the exposure amount for derivative contracts. SA–CCR will replace the existing CEM methodology for advanced approaches institutions. Non-advanced approaches banking organizations will have the option of using SA–CCR in place of CEM. 2. The Significant Issues Raised by the Public Comments in Response to the Initial Regulatory Flexibility Analysis No significant issues were raised by the public comments in response to the initial regulatory flexibility analysis. 3. Response of the Agency to Any Comments Filed by the Chief Counsel for Advocacy of the Small Business Administration in Response to the Proposed Rule lotter on DSKBCFDHB2PROD with RULES2 No comments were filed by the Chief Counsel for Advocacy of the Small Business Administration in response to the proposed rule. 150 The SBA defines a small banking organization as having $600 million or less in assets, where an organization’s ‘‘assets are determined by averaging the assets reported on its four quarterly financial statements for the preceding year.’’ See 13 CFR 121.201 (as amended by 84 FR 34261, effective August 19, 2019). In its determination, the ‘‘SBA counts the receipts, employees, or other measure of size of the concern whose size is at issue and all of its domestic and foreign affiliates.’’ See 13 CFR 121.103. Following these regulations, the FDIC uses a covered entity’s affiliated and acquired assets, averaged over the preceding four quarters, to determine whether the covered entity is ‘‘small’’ for the purposes of RFA. VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 4. A Description of and an Estimate of the Number of Small Entities to Which the Rule Will Apply or an Explanation of Why no Such Estimate Is Available As of June 30, 2019, the FDIC supervised 3,424 institutions, of which 2,665 are considered small entities for the purposes of RFA. These small IDIs hold $514 billion in assets, accounting for 16.6 percent of total assets held by FDIC-supervised institutions.151 The final rule will require advanced approaches institutions to use either SA–CCR or IMM to calculate the exposure amount of its noncleared and cleared derivative contracts under the advanced approaches. For purposes of determining the exposure amount of its noncleared and cleared derivative contracts under the standardized approach, an advanced approaches institution must use SA–CCR. An advanced approaches institution must use SA–CCR to determine the riskweighted asset amount of its default fund contributions under both the approaches. There are no FDICsupervised advanced approaches institutions that are considered small entities for the purposes of RFA.152 The final rule will allow, but not require, non-advanced approaches institutions to replace CEM with SA– CCR as the approach for calculating EAD. While this allowance applies to all 2,665 small entities, only 401 (15 percent) report holding any volume of derivatives and would therefore be affected by differences between CEM and SA–CCR. These 401 banks’ holdings of derivatives account for only 7.6 percent of their assets, so the effects of calculating the exposure amount of derivatives using SA–CCR on their capital requirements would likely be insignificant.153 Since adoption of SA– CCR is optional, these banks would weigh the benefits of SA–CCR adoption against its costs. Given that SA–CCR adoption necessitates internal systems enhancements and other operational modifications that could be particularly burdensome for smaller, less complex banking organizations, the FDIC expects that no small institutions will likely adopt SA–CCR. 5. A Description of the Projected Reporting, Recordkeeping and Other Compliance Requirements of the Rule No small entity will be compelled to use SA–CCR, so the rule does not impose any reporting, recordkeeping 151 Consolidated Reports of Condition and Income for the quarter ending June 30, 2019. 152 Id. 153 Id. PO 00000 Frm 00038 Fmt 4701 Sfmt 4702 and other compliance requirements onto small entities. The FDIC does not expect any small entity to adopt SA–CCR, given the internal systems enhancements and operational modifications needed for SA–CCR adoption. A small institution will elect to use SA–CCR only if the net benefits of doing so are positive. Thus, the FDIC expects the proposed rule will not impose any net economic costs on these entities. 6. A Description of the Steps the Agency Has Taken To Minimize the Significant Economic Impact on Small Entities As described above, the FDIC does not believe this rule will have a significant economic impact on a substantial number of small entities. Further, since adopting SA–CCR is voluntary, only entities that expect to benefit from SA– CCR will adopt it. Board: An initial regulatory flexibility analysis (IRFA) was included in the proposal in accordance with section 603(a) of the Regulatory Flexibility Act (RFA), 5 U.S.C. 601 et seq. In the IRFA, the Board requested comment on the effect of the proposed rule on small entities and on any significant alternatives that would reduce the regulatory burden on small entities. The Board did not receive any comments on the IRFA. The RFA requires an agency to prepare a final regulatory flexibility analysis unless the agency certifies that the rule will not, if promulgated, have a significant economic impact on a substantial number of small entities. Based on its analysis, and for the reasons stated below, the Board certifies that the rule will not have a significant economic impact on a substantial number of small entities.154 Under regulations issued by the Small Business Administration, a small entity includes a bank, bank holding company, or savings and loan holding company with assets of $600 million or less and trust companies with total assets of $41.5 million or less (small banking organization).155 As of June 30, 2019, there were approximately 2,976 small bank holding companies, 133 small savings and loan holding companies, and 537 small SMBs. As discussed in the SUPPLEMENTARY INFORMATION section, the final rule revises the capital rule to provide a new and more risk-sensitive methodology for calculating the exposure amount for derivative contracts. For purposes of 154 5 U.S.C. 605(b). 13 CFR 121.201. Effective August 19, 2019, the SBA revised the size standards for banking organizations to $600 million in assets from $550 million in assets. 84 FR 34261 (July 18, 2019). 155 See E:\FR\FM\24JAR2.SGM 24JAR2 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations lotter on DSKBCFDHB2PROD with RULES2 calculating advanced approaches total risk-weighted assets, an advanced approaches Board-regulated institution may use either SA–CCR or the internal models methodology. For purposes of calculating standardized total riskweighted assets, an advanced approaches Board-regulated institution must use SA–CCR and a non-advanced approaches Board-regulated institution may elect either SA–CCR or CEM.156 In addition, for purposes of the denominator of the supplementary leverage ratio, the final rule integrates SA–CCR into the calculation of the denominator, replacing CEM.157 The Board does not expect that the final rule will result in a material change in the level of capital maintained by small banking organizations or in the compliance burden on small banking organizations because the framework is optional for non-advanced approaches banking organizations. To the extent that small banking organizations elect to adopt SA–CCR because it provides advantageous regulatory capital treatment of derivatives, any implementation costs or increased compliance costs associated with SA– CCR should be outweighed by the capital impact of SA–CCR. In any event, small banking organizations generally do not have substantial portfolios of derivative contracts and therefore any impact of SA–CCR on capital requirements is expected to be minimal. For these reasons, the Board does not expect the rule to have a significant economic impact on a substantial number of small entities. 156 Advanced approaches banking organizations include depository institutions, bank holding companies, savings and loan holding companies, or intermediate holding companies subject to Category I or Category II standards. See supra note 23. 157 In general, the Board’s capital rule only applies to bank holding companies and savings and loan holding companies that are not subject to the Board’s Small Bank Holding Company and Savings and Loan Holding Company Policy Statement, which applies to bank holding companies and savings and loan holding companies with less than $3 billion in total assets that also meet certain additional criteria. In addition, the agencies recently adopted a final rule to implement a community bank leverage ratio framework that is applicable, on an optional basis to depository institutions and depository institution holding companies with less than $10 billion in total consolidated assets and that meet certain other criteria. Such banking organizations that opt into the community bank leverage ratio framework will be deemed compliant with the capital rule’s generally applicable requirements and are not required to calculate risk-based capital ratios. See supra note 3. Very few bank holding companies and savings and loan holding companies that are small entities would be impacted by the final rule because very few such entities are subject to the Board’s capital rule. VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 C. Plain Language Section 722 of the Gramm-LeachBliley Act 158 requires the Federal banking agencies to use plain language in all proposed and final rules published after January 1, 2000. The agencies have sought to present the final rule in a simple and straightforward manner, and did not receive comment on the use of plain language. D. Riegle Community Development and Regulatory Improvement Act of 1994 Pursuant to section 302(a) of the Riegle Community Development and Regulatory Improvement Act (RCDRIA),159 in determining the effective date and administrative compliance requirements for new regulations that impose additional reporting, disclosure, or other requirements on IDIs, each Federal banking agency must consider, consistent with principles of safety and soundness and the public interest, any administrative burdens that such regulations would place on depository institutions, including small depository institutions, and customers of depository institutions, as well as the benefits of such regulations. In addition, section 302(b) of RCDRIA requires new regulations and amendments to regulations that impose additional reporting, disclosures, or other new requirements on IDIs generally to take effect on the first day of a calendar quarter that begins on or after the date on which the regulations are published in final form.160 In accordance with these provisions of RCDRIA, the agencies considered any administrative burdens, as well as benefits, that the final rule would place on depository institutions and their customers in determining the effective date and administrative compliance requirements of the final rule. In conjunction with the requirements of RCDRIA, the final rule is effective on April 1, 2020. E. OCC Unfunded Mandates Reform Act of 1995 Determination The OCC analyzed the proposed rule under the factors set forth in the Unfunded Mandates Reform Act of 1995 (UMRA) (2 U.S.C. 1532). Under this analysis, the OCC considered whether the final rule includes a Federal mandate that may result in the expenditure by State, local, and Tribal governments, in the aggregate, or by the private sector, of $100 million or more 158 See Public Law 106–102, section 722, 113 Stat. 1338, 1471 (1999). 159 12 U.S.C. 4802(a). 160 12 U.S.C. 4802. PO 00000 Frm 00039 Fmt 4701 Sfmt 4702 4399 in any one year (adjusted for inflation). The OCC has determined that this final rule would not result in expenditures by State, local, and Tribal governments, or the private sector, of $100 million or more in any one year. Accordingly, the OCC has not prepared a written statement to accompany this proposal. F. The Congressional Review Act For purposes of Congressional Review Act, the OMB makes a determination as to whether a final rule constitutes a ‘‘major’’ rule.161 If a rule is deemed a ‘‘major rule’’ by the OMB, the Congressional Review Act generally provides that the rule may not take effect until at least 60 days following its publication.162 The Congressional Review Act defines a ‘‘major rule’’ as any rule that the Administrator of the Office of Information and Regulatory Affairs of the OMB finds has resulted in or is likely to result in—(A) an annual effect on the economy of $100,000,000 or more; (B) a major increase in costs or prices for consumers, individual industries, Federal, State, or local government agencies or geographic regions, or (C) significant adverse effects on competition, employment, investment, productivity, innovation, or on the ability of United States-based enterprises to compete with foreignbased enterprises in domestic and export markets.163 As required by the Congressional Review Act, the agencies will submit the final rule and other appropriate reports to Congress and the Government Accountability Office for review. List of Subjects 12 CFR Part 3 Administrative practice and procedure, Capital, National banks, Risk. 12 CFR Part 32 National banks, Reporting and recordkeeping requirements. 12 CFR Part 217 Administrative practice and procedure, Banks, Banking, Capital, Federal Reserve System, Holding companies. 12 CFR Part 324 Administrative practice and procedure, Banks, Banking, Capital adequacy, Savings associations, State non-member banks. 161 5 U.S.C. 801 et seq. U.S.C. 801(a)(3). 163 5 U.S.C. 804(2). 162 5 E:\FR\FM\24JAR2.SGM 24JAR2 4400 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 12 CFR Part 327 Bank deposit insurance, Banks, Banking, Savings associations. Office of the Comptroller of the Currency For the reasons set out in the joint preamble, the OCC amends 12 CFR parts 3 and 32 as follows: PART 3—CAPITAL ADEQUACY STANDARDS 1. The authority citation for part 3 continues to read as follows: ■ Authority: 12 U.S.C. 93a, 161, 1462, 1462a, 1463, 1464, 1818, 1828(n), 1828 note, 1831n note, 1835, 3907, 3909, and 5412(b)(2)(B). 2. Section 3.2 is amended by: a. Adding the definitions of ‘‘Basis derivative contract,’’ ‘‘Client-facing derivative transaction,’’ and ‘‘Commercial end-user’’ in alphabetical order; ■ b. Revising the definitions of ‘‘Current exposure’’ and ‘‘Current exposure methodology;’’ ■ c. Revising paragraph (2) of the definition of ‘‘Financial collateral;’’ ■ d. Adding the definitions of ‘‘Independent collateral,’’ ‘‘Minimum transfer amount,’’ and ‘‘Net independent collateral amount’’ in alphabetical order; ■ e. Revising the definition of ‘‘Netting set;’’ and ■ f. Adding the definitions of ‘‘Speculative grade,’’ ‘‘Sub-speculative grade,’’ ‘‘Variation margin,’’ ‘‘Variation margin agreement,’’ ‘‘Variation margin amount,’’ ‘‘Variation margin threshold,’’ and ‘‘Volatility derivative contract’’ in alphabetical order. The additions and revisions read as follows: ■ ■ § 3.2 Definitions. lotter on DSKBCFDHB2PROD with RULES2 * * * * * Basis derivative contract means a nonforeign-exchange derivative contract (i.e., the contract is denominated in a single currency) in which the cash flows of the derivative contract depend on the difference between two risk factors that are attributable solely to one of the following derivative asset classes: Interest rate, credit, equity, or commodity. * * * * * Client-facing derivative transaction means a derivative contract that is not a cleared transaction where the national bank or Federal savings association is either acting as a financial intermediary and enters into an offsetting transaction with a qualifying central counterparty (QCCP) or where the national bank or Federal savings association provides a VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 guarantee on the performance of a client on a transaction between the client and a QCCP. * * * * * Commercial end-user means an entity that: (1)(i) Is using derivative contracts to hedge or mitigate commercial risk; and (ii)(A) Is not an entity described in section 2(h)(7)(C)(i)(I) through (VIII) of the Commodity Exchange Act (7 U.S.C. 2(h)(7)(C)(i)(I) through (VIII)); or (B) Is not a ‘‘financial entity’’ for purposes of section 2(h)(7) of the Commodity Exchange Act (7 U.S.C. 2(h)) by virtue of section 2(h)(7)(C)(iii) of the Act (7 U.S.C. 2(h)(7)(C)(iii)); or (2)(i) Is using derivative contracts to hedge or mitigate commercial risk; and (ii) Is not an entity described in section 3C(g)(3)(A)(i) through (viii) of the Securities Exchange Act of 1934 (15 U.S.C. 78c–3(g)(3)(A)(i) through (viii)); or (3) Qualifies for the exemption in section 2(h)(7)(A) of the Commodity Exchange Act (7 U.S.C. 2(h)(7)(A)) by virtue of section 2(h)(7)(D) of the Act (7 U.S.C. 2(h)(7)(D)); or (4) Qualifies for an exemption in section 3C(g)(1) of the Securities Exchange Act of 1934 (15 U.S.C. 78c– 3(g)(1)) by virtue of section 3C(g)(4) of the Act (15 U.S.C. 78c–3(g)(4)). * * * * * Current exposure means, with respect to a netting set, the larger of zero or the fair value of a transaction or portfolio of transactions within the netting set that would be lost upon default of the counterparty, assuming no recovery on the value of the transactions. Current exposure methodology means the method of calculating the exposure amount for over-the-counter derivative contracts in § 3.34(b). * * * * * Financial collateral * * * (2) In which the national bank and Federal savings association has a perfected, first-priority security interest or, outside of the United States, the legal equivalent thereof (with the exception of cash on deposit; and notwithstanding the prior security interest of any custodial agent or any priority security interest granted to a CCP in connection with collateral posted to that CCP). * * * * * Independent collateral means financial collateral, other than variation margin, that is subject to a collateral agreement, or in which a national bank and Federal savings association has a perfected, first-priority security interest or, outside of the United States, the legal equivalent thereof (with the exception of cash on deposit; notwithstanding the PO 00000 Frm 00040 Fmt 4701 Sfmt 4702 prior security interest of any custodial agent or any prior security interest granted to a CCP in connection with collateral posted to that CCP), and the amount of which does not change directly in response to the value of the derivative contract or contracts that the financial collateral secures. * * * * * Minimum transfer amount means the smallest amount of variation margin that may be transferred between counterparties to a netting set pursuant to the variation margin agreement. * * * * * Net independent collateral amount means the fair value amount of the independent collateral, as adjusted by the standard supervisory haircuts under § 3.132(b)(2)(ii), as applicable, that a counterparty to a netting set has posted to a national bank or Federal savings association less the fair value amount of the independent collateral, as adjusted by the standard supervisory haircuts under § 3.132(b)(2)(ii), as applicable, posted by the national bank or Federal savings association to the counterparty, excluding such amounts held in a bankruptcy remote manner or posted to a QCCP and held in conformance with the operational requirements in § 3.3. Netting set means a group of transactions with a single counterparty that are subject to a qualifying master netting agreement. For derivative contracts, netting set also includes a single derivative contract between a national bank or Federal savings association and a single counterparty. For purposes of the internal model methodology under § 3.132(d), netting set also includes a group of transactions with a single counterparty that are subject to a qualifying cross-product master netting agreement and does not include a transaction: (1) That is not subject to such a master netting agreement; or (2) Where the national bank or Federal savings association has identified specific wrong-way risk. * * * * * Speculative grade means the reference entity has adequate capacity to meet financial commitments in the near term, but is vulnerable to adverse economic conditions, such that should economic conditions deteriorate, the reference entity would present an elevated default risk. * * * * * Sub-speculative grade means the reference entity depends on favorable economic conditions to meet its financial commitments, such that should such economic conditions deteriorate the reference entity likely E:\FR\FM\24JAR2.SGM 24JAR2 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations would default on its financial commitments. * * * * * Variation margin means financial collateral that is subject to a collateral agreement provided by one party to its counterparty to meet the performance of the first party’s obligations under one or more transactions between the parties as a result of a change in value of such obligations since the last time such financial collateral was provided. Variation margin agreement means an agreement to collect or post variation margin. Variation margin amount means the fair value amount of the variation margin, as adjusted by the standard supervisory haircuts under § 3.132(b)(2)(ii), as applicable, that a counterparty to a netting set has posted to a national bank or Federal savings association less the fair value amount of the variation margin, as adjusted by the standard supervisory haircuts under § 3.132(b)(2)(ii), as applicable, posted by the national bank or Federal savings association to the counterparty. Variation margin threshold means the amount of credit exposure of a national bank or Federal savings association to its counterparty that, if exceeded, would require the counterparty to post variation margin to the national bank or Federal savings association pursuant to the variation margin agreement. Volatility derivative contract means a derivative contract in which the payoff of the derivative contract explicitly depends on a measure of the volatility of an underlying risk factor to the derivative contract. * * * * * ■ 3. Section 3.10 is amended by revising paragraphs (c)(4)(ii)(A) through (C) to read as follows: § 3.10 Minimum capital requirements. lotter on DSKBCFDHB2PROD with RULES2 * * * * * (c) * * * (4) * * * (ii) * * * (A) The balance sheet carrying value of all of the national bank or Federal savings association’s on-balance sheet assets, plus the value of securities sold under a repurchase transaction or a securities lending transaction that qualifies for sales treatment under U.S. GAAP, less amounts deducted from tier 1 capital under § 3.22(a), (c), and (d), and less the value of securities received in security-for-security repo-style transactions, where the national bank or Federal savings association acts as a securities lender and includes the securities received in its on-balance sheet assets but has not sold or re- VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 hypothecated the securities received, and, for a national bank or Federal savings association that uses the standardized approach for counterparty credit risk under § 3.132(c) for its standardized risk-weighted assets, less the fair value of any derivative contracts; (B)(1) For a national bank or Federal savings association that uses the current exposure methodology under § 3.34(b) for its standardized risk-weighted assets, the potential future credit exposure (PFE) for each derivative contract or each single-product netting set of derivative contracts (including a cleared transaction except as provided in paragraph (c)(4)(ii)(I) of this section and, at the discretion of the national bank or Federal savings association, excluding a forward agreement treated as a derivative contract that is part of a repurchase or reverse repurchase or a securities borrowing or lending transaction that qualifies for sales treatment under U.S. GAAP), to which the national bank or Federal savings association is a counterparty as determined under § 3.34, but without regard to § 3.34(b), provided that: (i) A national bank or Federal savings association may choose to exclude the PFE of all credit derivatives or other similar instruments through which it provides credit protection when calculating the PFE under § 3.34, but without regard to § 3.34(b), provided that it does not adjust the net-to-gross ratio (NGR); and (ii) A national bank or Federal savings association that chooses to exclude the PFE of credit derivatives or other similar instruments through which it provides credit protection pursuant to paragraph (c)(4)(ii)(B)(1) of this section must do so consistently over time for the calculation of the PFE for all such instruments; or (2)(i) For a national bank or Federal savings association that uses the standardized approach for counterparty credit risk under section § 3.132(c) for its standardized risk-weighted assets, the PFE for each netting set to which the national bank or Federal savings association is a counterparty (including cleared transactions except as provided in paragraph (c)(4)(ii)(I) of this section and, at the discretion of the national bank or Federal savings association, excluding a forward agreement treated as a derivative contract that is part of a repurchase or reverse repurchase or a securities borrowing or lending transaction that qualifies for sales treatment under U.S. GAAP), as determined under § 3.132(c)(7)(i), in which the term C in § 3.132(c)(7)(i) equals zero except as provided in PO 00000 Frm 00041 Fmt 4701 Sfmt 4702 4401 paragraph (c)(4)(ii)(B)(2)(ii) of this section, and, for any counterparty that is not a commercial end-user, multiplied by 1.4; and (ii) For purposes of paragraph (c)(4)(ii)(B)(2)(i) of this section, a national bank or Federal savings association may set the value of the term C in § 3.132(c)(7)(i) equal to the amount of collateral posted by a clearing member client of the national bank or Federal savings association, in connection with the client-facing derivative transactions within the netting set; (C)(1)(i) For a national bank or Federal savings association that uses the current exposure methodology under § 3.34(b) for its standardized risk-weighted assets, the amount of cash collateral that is received from a counterparty to a derivative contract and that has offset the mark-to-fair value of the derivative asset, or cash collateral that is posted to a counterparty to a derivative contract and that has reduced the national bank or Federal savings association’s onbalance sheet assets, unless such cash collateral is all or part of variation margin that satisfies the conditions in paragraphs (c)(4)(ii)(C)(3) through (7) of this section; and (ii) The variation margin is used to reduce the current credit exposure of the derivative contract, calculated as described in § 3.34(b), and not the PFE; and (iii) For the purpose of the calculation of the NGR described in § 3.34(b)(2)(ii)(B), variation margin described in paragraph (c)(4)(ii)(C)(1)(ii) of this section may not reduce the net current credit exposure or the gross current credit exposure; or (2)(i) For a national bank or Federal savings association that uses the standardized approach for counterparty credit risk under § 3.132(c) for its standardized risk-weighted assets, the replacement cost of each derivative contract or single product netting set of derivative contracts to which the national bank or Federal savings association is a counterparty, calculated according to the following formula, and, for any counterparty that is not a commercial end-user, multiplied by 1.4: Replacement Cost = max{V¥CVMr + CVMp;0} Where: V equals the fair value for each derivative contract or each single-product netting set of derivative contracts (including a cleared transaction except as provided in paragraph (c)(4)(ii)(I) of this section and, at the discretion of the national bank or Federal savings association, excluding a forward agreement treated as a derivative contract that is part of a repurchase or E:\FR\FM\24JAR2.SGM 24JAR2 4402 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations lotter on DSKBCFDHB2PROD with RULES2 reverse repurchase or a securities borrowing or lending transaction that qualifies for sales treatment under U.S. GAAP); CVMr equals the amount of cash collateral received from a counterparty to a derivative contract and that satisfies the conditions in paragraphs (c)(4)(ii)(C)(3) through (7) of this section, or, in the case of a client-facing derivative transaction, the amount of collateral received from the clearing member client; and CVMp equals the amount of cash collateral that is posted to a counterparty to a derivative contract and that has not offset the fair value of the derivative contract and that satisfies the conditions in paragraphs (c)(4)(ii)(C)(3) through (7) of this section, or, in the case of a clientfacing derivative transaction, the amount of collateral posted to the clearing member client; (ii) Notwithstanding paragraph (c)(4)(ii)(C)(2)(i) of this section, where multiple netting sets are subject to a single variation margin agreement, a national bank or Federal savings association must apply the formula for replacement cost provided in § 3.132(c)(10)(i), in which the term CMA may only include cash collateral that satisfies the conditions in paragraphs (c)(4)(ii)(C)(3) through (7) of this section; and (iii) For purposes of paragraph (c)(4)(ii)(C)(2)(i), a national bank or Federal savings association must treat a derivative contract that references an index as if it were multiple derivative contracts each referencing one component of the index if the national bank or Federal savings association elected to treat the derivative contract as multiple derivative contracts under § 3.132(c)(5)(vi); (3) For derivative contracts that are not cleared through a QCCP, the cash collateral received by the recipient counterparty is not segregated (by law, regulation, or an agreement with the counterparty); (4) Variation margin is calculated and transferred on a daily basis based on the mark-to-fair value of the derivative contract; (5) The variation margin transferred under the derivative contract or the governing rules of the CCP or QCCP for a cleared transaction is the full amount that is necessary to fully extinguish the net current credit exposure to the counterparty of the derivative contracts, subject to the threshold and minimum transfer amounts applicable to the counterparty under the terms of the derivative contract or the governing rules for a cleared transaction; (6) The variation margin is in the form of cash in the same currency as the currency of settlement set forth in the VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 derivative contract, provided that for the purposes of this paragraph (c)(4)(ii)(C)(6), currency of settlement means any currency for settlement specified in the governing qualifying master netting agreement and the credit support annex to the qualifying master netting agreement, or in the governing rules for a cleared transaction; and (7) The derivative contract and the variation margin are governed by a qualifying master netting agreement between the legal entities that are the counterparties to the derivative contract or by the governing rules for a cleared transaction, and the qualifying master netting agreement or the governing rules for a cleared transaction must explicitly stipulate that the counterparties agree to settle any payment obligations on a net basis, taking into account any variation margin received or provided under the contract if a credit event involving either counterparty occurs; * * * * * ■ 4. Section 3.32 is amended by revising paragraph (f) to read as follows: § 3.32 General risk weights. * * * * * (f) Corporate exposures. (1) A national bank or Federal savings association must assign a 100 percent risk weight to all its corporate exposures, except as provided in paragraph (f)(2) of this section. (2) A national bank or Federal savings association must assign a 2 percent risk weight to an exposure to a QCCP arising from the national bank or Federal savings association posting cash collateral to the QCCP in connection with a cleared transaction that meets the requirements of § 3.35(b)(3)(i)(A) and a 4 percent risk weight to an exposure to a QCCP arising from the national bank or Federal savings association posting cash collateral to the QCCP in connection with a cleared transaction that meets the requirements of § 3.35(b)(3)(i)(B). (3) A national bank or Federal savings association must assign a 2 percent risk weight to an exposure to a QCCP arising from the national bank or Federal savings association posting cash collateral to the QCCP in connection with a cleared transaction that meets the requirements of § 3.35(c)(3)(i). * * * * * ■ 5. Section 3.34 is revised to read as follows: § 3.34 Derivative contracts. (a) Exposure amount for derivative contracts—(1) National bank or Federal savings association that is not an advanced approaches national bank or PO 00000 Frm 00042 Fmt 4701 Sfmt 4702 Federal savings association. (i) A national bank or Federal savings association that is not an advanced approaches national bank or Federal savings association must use the current exposure methodology (CEM) described in paragraph (b) of this section to calculate the exposure amount for all its OTC derivative contracts, unless the national bank or Federal savings association makes the election provided in paragraph (a)(1)(ii) of this section. (ii) A national bank or Federal savings association that is not an advanced approaches national bank or Federal savings association may elect to calculate the exposure amount for all its OTC derivative contracts under the standardized approach for counterparty credit risk (SA–CCR) in § 3.132(c) by notifying the OCC, rather than calculating the exposure amount for all its derivative contracts using CEM. A national bank or Federal savings association that elects under this paragraph (a)(1)(ii) to calculate the exposure amount for its OTC derivative contracts under SA–CCR must apply the treatment of cleared transactions under § 3.133 to its derivative contracts that are cleared transactions and to all default fund contributions associated with such derivative contracts, rather than applying § 3.35. A national bank or Federal savings association that is not an advanced approaches national bank or Federal savings association must use the same methodology to calculate the exposure amount for all its derivative contracts and, if a national bank or Federal savings association has elected to use SA–CCR under this paragraph (a)(1)(ii), the national bank or Federal savings association may change its election only with prior approval of the OCC. (2) Advanced approaches national bank or Federal savings association. An advanced approaches national bank or Federal savings association must calculate the exposure amount for all its derivative contracts using SA–CCR in § 3.132(c) for purposes of standardized total risk-weighted assets. An advanced approaches national bank or Federal savings association must apply the treatment of cleared transactions under § 3.133 to its derivative contracts that are cleared transactions and to all default fund contributions associated with such derivative contracts for purposes of standardized total riskweighted assets. (b) Current exposure methodology exposure amount—(1) Single OTC derivative contract. Except as modified by paragraph (c) of this section, the exposure amount for a single OTC derivative contract that is not subject to E:\FR\FM\24JAR2.SGM 24JAR2 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations a qualifying master netting agreement is equal to the sum of the national bank’s or Federal savings association’s current credit exposure and potential future credit exposure (PFE) on the OTC derivative contract. (i) Current credit exposure. The current credit exposure for a single OTC derivative contract is the greater of the fair value of the OTC derivative contract or zero. (ii) PFE. (A) The PFE for a single OTC derivative contract, including an OTC derivative contract with a negative fair value, is calculated by multiplying the notional principal amount of the OTC 4403 section, the PFE must be calculated using the appropriate ‘‘other’’ conversion factor. (D) A national bank or Federal savings association must use an OTC derivative contract’s effective notional principal amount (that is, the apparent or stated notional principal amount multiplied by any multiplier in the OTC derivative contract) rather than the apparent or stated notional principal amount in calculating PFE. (E) The PFE of the protection provider of a credit derivative is capped at the net present value of the amount of unpaid premiums. derivative contract by the appropriate conversion factor in Table 1 to this section. (B) For purposes of calculating either the PFE under this paragraph (b)(1)(ii) or the gross PFE under paragraph (b)(2)(ii)(A) of this section for exchange rate contracts and other similar contracts in which the notional principal amount is equivalent to the cash flows, notional principal amount is the net receipts to each party falling due on each value date in each currency. (C) For an OTC derivative contract that does not fall within one of the specified categories in Table 1 to this TABLE 1 TO § 3.34—CONVERSION FACTOR MATRIX FOR DERIVATIVE CONTRACTS 1 Remaining maturity 2 Foreign exchange rate and gold Interest rate One year or less ........................................... Greater than one year and less than or equal to five years ..................................... Greater than five years ................................. Credit (noninvestmentgrade reference asset) Credit (investment grade reference asset) 3 Precious metals (except gold) Equity Other 0.00 0.01 0.05 0.10 0.06 0.07 0.10 0.005 0.015 0.05 0.075 0.05 0.05 0.10 0.10 0.08 0.10 0.07 0.08 0.12 0.15 lotter on DSKBCFDHB2PROD with RULES2 1 For a derivative contract with multiple exchanges of principal, the conversion factor is multiplied by the number of remaining payments in the derivative contract. 2 For an OTC derivative contract that is structured such that on specified dates any outstanding exposure is settled and the terms are reset so that the fair value of the contract is zero, the remaining maturity equals the time until the next reset date. For an interest rate derivative contract with a remaining maturity of greater than one year that meets these criteria, the minimum conversion factor is 0.005. 3 A national bank or Federal savings association must use the column labeled ‘‘Credit (investment-grade reference asset)’’ for a credit derivative whose reference asset is an outstanding unsecured long-term debt security without credit enhancement that is investment grade. A national bank or Federal savings association must use the column labeled ‘‘Credit (non-investment-grade reference asset)’’ for all other credit derivatives. (2) Multiple OTC derivative contracts subject to a qualifying master netting agreement. Except as modified by paragraph (c) of this section, the exposure amount for multiple OTC derivative contracts subject to a qualifying master netting agreement is equal to the sum of the net current credit exposure and the adjusted sum of the PFE amounts for all OTC derivative contracts subject to the qualifying master netting agreement. (i) Net current credit exposure. The net current credit exposure is the greater of the net sum of all positive and negative fair values of the individual OTC derivative contracts subject to the qualifying master netting agreement or zero. (ii) Adjusted sum of the PFE amounts. The adjusted sum of the PFE amounts, Anet, is calculated as Anet = (0.4 × Agross) + (0.6 × NGR × Agross), where: (A) Agross = the gross PFE (that is, the sum of the PFE amounts as determined under paragraph (b)(1)(ii) of this section for each individual derivative contract subject to the qualifying master netting agreement); and (B) Net-to-gross Ratio (NGR) = the ratio of the net current credit exposure to the gross current credit exposure. In calculating the NGR, the gross current credit exposure equals the sum of the VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 positive current credit exposures (as determined under paragraph (b)(1)(i) of this section) of all individual derivative contracts subject to the qualifying master netting agreement. (c) Recognition of credit risk mitigation of collateralized OTC derivative contracts. (1) A national bank or Federal savings association using CEM under paragraph (b) of this section may recognize the credit risk mitigation benefits of financial collateral that secures an OTC derivative contract or multiple OTC derivative contracts subject to a qualifying master netting agreement (netting set) by using the simple approach in § 3.37(b). (2) As an alternative to the simple approach, a national bank or Federal savings association using CEM under paragraph (b) of this section may recognize the credit risk mitigation benefits of financial collateral that secures such a contract or netting set if the financial collateral is marked-to-fair value on a daily basis and subject to a daily margin maintenance requirement by applying a risk weight to the uncollateralized portion of the exposure, after adjusting the exposure amount calculated under paragraph (b)(1) or (2) of this section using the collateral haircut approach in § 3.37(c). The national bank or Federal savings PO 00000 Frm 00043 Fmt 4701 Sfmt 4702 association must substitute the exposure amount calculated under paragraph (b)(1) or (2) of this section for SE in the equation in § 3.37(c)(2). (d) Counterparty credit risk for credit derivatives—(1) Protection purchasers. A national bank or Federal savings association that purchases a credit derivative that is recognized under § 3.36 as a credit risk mitigant for an exposure that is not a covered position under subpart F of this part is not required to compute a separate counterparty credit risk capital requirement under this subpart provided that the national bank or Federal savings association does so consistently for all such credit derivatives. The national bank or Federal savings association must either include all or exclude all such credit derivatives that are subject to a qualifying master netting agreement from any measure used to determine counterparty credit risk exposure to all relevant counterparties for risk-based capital purposes. (2) Protection providers. (i) A national bank or Federal savings association that is the protection provider under a credit derivative must treat the credit derivative as an exposure to the underlying reference asset. The national bank or Federal savings association is E:\FR\FM\24JAR2.SGM 24JAR2 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations not required to compute a counterparty credit risk capital requirement for the credit derivative under this subpart, provided that this treatment is applied consistently for all such credit derivatives. The national bank or Federal savings association must either include all or exclude all such credit derivatives that are subject to a qualifying master netting agreement from any measure used to determine counterparty credit risk exposure. (ii) The provisions of this paragraph (d)(2) apply to all relevant counterparties for risk-based capital purposes unless the national bank or Federal savings association is treating the credit derivative as a covered position under subpart F of this part, in which case the national bank or Federal savings association must compute a supplemental counterparty credit risk capital requirement under this section. (e) Counterparty credit risk for equity derivatives. (1) A national bank or Federal savings association must treat an equity derivative contract as an equity exposure and compute a riskweighted asset amount for the equity derivative contract under §§ 3.51 through 3.53 (unless the national bank or Federal savings association is treating the contract as a covered position under subpart F of this part). (2) In addition, the national bank or Federal savings association must also calculate a risk-based capital requirement for the counterparty credit risk of an equity derivative contract under this section if the national bank or Federal savings association is treating the contract as a covered position under subpart F of this part. (3) If the national bank or Federal savings association risk weights the contract under the Simple Risk-Weight Approach (SRWA) in § 3.52, the national bank or Federal savings association may choose not to hold riskbased capital against the counterparty credit risk of the equity derivative contract, as long as it does so for all such contracts. Where the equity derivative contracts are subject to a qualified master netting agreement, a national bank or Federal savings association using the SRWA must either include all or exclude all of the contracts from any measure used to determine counterparty credit risk exposure. (f) Clearing member national bank’s or Federal savings association’s exposure amount. The exposure amount of a clearing member national bank or Federal savings association using CEM under paragraph (b) of this section for a client-facing derivative transaction or netting set of client-facing derivative VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 transactions equals the exposure amount calculated according to paragraph (b)(1) or (2) of this section multiplied by the scaling factor of the square root of 1⁄2 (which equals 0.707107). If the national bank or Federal savings association determines that a longer period is appropriate, the national bank or Federal savings association must use a larger scaling factor to adjust for a longer holding period as follows: Scaling factor = /H ✓w Where H = the holding period greater than or equal to five days. Additionally, the OCC may require the national bank or Federal savings association to set a longer holding period if the OCC determines that a longer period is appropriate due to the nature, structure, or characteristics of the transaction or is commensurate with the risks associated with the transaction. ■ 6. Section 3.35 is amended by adding paragraph (a)(3), revising paragraph (b)(4)(i), and adding paragraph (c)(3)(iii) to read as follows: § 3.35 Cleared transactions. (a) * * * (3) Alternate requirements. Notwithstanding any other provision of this section, an advanced approaches national bank or Federal savings association or a national bank or Federal savings association that is not an advanced approaches national bank or Federal savings association and that has elected to use SA–CCR under § 3.34(a)(1) must apply § 3.133 to its derivative contracts that are cleared transactions rather than this section. (b) * * * (4) * * * (i) Notwithstanding any other requirements in this section, collateral posted by a clearing member client national bank or Federal savings association that is held by a custodian (in its capacity as custodian) in a manner that is bankruptcy remote from the CCP, clearing member, and other clearing member clients of the clearing member, is not subject to a capital requirement under this section. * * * * * (c) * * * (3) * * * (iii) Notwithstanding paragraphs (c)(3)(i) and (ii) of this section, a clearing member national bank or Federal savings association may apply a risk weight of zero percent to the trade exposure amount for a cleared transaction with a CCP where the PO 00000 Frm 00044 Fmt 4701 Sfmt 4702 clearing member national bank or Federal savings association is acting as a financial intermediary on behalf of a clearing member client, the transaction offsets another transaction that satisfies the requirements set forth in § 3.3(a), and the clearing member national bank or Federal savings association is not obligated to reimburse the clearing member client in the event of the CCP default. * * * * * 7. Section 3.37 is amended by revising paragraphs (c)(3)(iii), (c)(3)(iv)(A) and (C), (c)(4)(i)(B) introductory text, and (c)(4)(i)(B)(1) to read as follows: ■ § 3.37 Collateralized transactions. * * * * * (c) * * * (3) * * * (iii) For repo-style transactions and client-facing derivative transactions, a national bank or Federal savings association may multiply the standard supervisory haircuts provided in paragraphs (c)(3)(i) and (ii) of this section by the square root of 1⁄2 (which equals 0.707107). For client-facing derivative transactions, if a larger scaling factor is applied under § 3.34(f), the same factor must be used to adjust the supervisory haircuts. (iv) * * * (A) TM equals a holding period of longer than 10 business days for eligible margin loans and derivative contracts other than client-facing derivative transactions or longer than 5 business days for repo-style transactions and client-facing derivative transactions; * * * * * (C) TS equals 10 business days for eligible margin loans and derivative contracts other than client-facing derivative transactions or 5 business days for repo-style transactions and client-facing derivative transactions. * * * * * (4) * * * (i) * * * (B) The minimum holding period for a repo-style transaction and clientfacing derivative transaction is five business days and for an eligible margin loan and a derivative contract other than a client-facing derivative transaction is ten business days except for transactions or netting sets for which paragraph (c)(4)(i)(C) of this section applies. When a national bank or Federal savings association calculates an own-estimates haircut on a TN-day holding period, which is different from the minimum holding period for the transaction type, the applicable haircut E:\FR\FM\24JAR2.SGM 24JAR2 ER24JA20.012</GPH> lotter on DSKBCFDHB2PROD with RULES2 4404 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations than client-facing derivative transactions; * * * * * § § 3.134, 3.202, and 3.210 [Amended] listed in the ‘‘Old footnote number’’ column is redesignated as the footnote number listed in the ‘‘New footnote number’’ column as follows: 8. For each section listed in the following table, the footnote number ■ Old footnote number Section 3.134(d)(3) ............................................................................................................................................................... 3.202, paragraph (1) introductory text of the definition of ‘‘Covered position’’ ....................................................... 3.202, paragraph (1)(i) of the definition of ‘‘Covered position’’ ............................................................................... 3.210(e)(1) ............................................................................................................................................................... 9. Section 3.132 is amended by: a. Revising paragraphs (b)(2)(ii)(A)(3) through (5); ■ b. Adding paragraphs (b)(2)(ii)(A)(6) and (7); ■ c. Revising paragraphs (c) heading and (c)(1) and (2) and (5) through (8); ■ d. Adding paragraphs (c)(9) through (11); ■ e. Revising paragraph (d)(10)(i); ■ f. In paragraphs (e)(5)(i)(A) and (H), removing ‘‘Table 3 to § 3.132’’ and adding in its place ‘‘Table 4 to this section’’; ■ g. In paragraphs (e)(5)(i)(C) and (e)(6)(i)(B), removing ‘‘current exposure methodology’’ and adding in its place ‘‘standardized approach for counterparty credit risk methodology’’ wherever it appears; ■ h. Redesignating Table 3 to § 3.132 following paragraph (e)(5)(ii) as Table 4 to § 3.132; and ■ i. Revising paragraph (e)(6)(viii). The revisions and additions read as follows: ■ ■ § 3.132 Counterparty credit risk of repostyle transactions, eligible margin loans, and OTC derivative contracts. lotter on DSKBCFDHB2PROD with RULES2 * * * * * (b) * * * (2) * * * (ii) * * * (A) * * * (3) For repo-style transactions and client-facing derivative transactions, a national bank or Federal savings association may multiply the supervisory haircuts provided in paragraphs (b)(2)(ii)(A)(1) and (2) of this section by the square root of 1⁄2 (which equals 0.707107). If the national bank or Federal savings association determines that a longer holding period is appropriate for client-facing derivative transactions, then it must use a larger scaling factor to adjust for the longer holding period pursuant to paragraph (b)(2)(ii)(A)(6) of this section. (4) A national bank or Federal savings association must adjust the supervisory haircuts upward on the basis of a VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 holding period longer than ten business days (for eligible margin loans) or five business days (for repo-style transactions), using the formula provided in paragraph (b)(2)(ii)(A)(6) of this section where the conditions in this paragraph (b)(2)(ii)(A)(4) apply. If the number of trades in a netting set exceeds 5,000 at any time during a quarter, a national bank or Federal savings association must adjust the supervisory haircuts upward on the basis of a minimum holding period of twenty business days for the following quarter (except when a national bank or Federal savings association is calculating EAD for a cleared transaction under § 3.133). If a netting set contains one or more trades involving illiquid collateral, a national bank or Federal savings association must adjust the supervisory haircuts upward on the basis of a minimum holding period of twenty business days. If over the two previous quarters more than two margin disputes on a netting set have occurred that lasted longer than the holding period, then the national bank or Federal savings association must adjust the supervisory haircuts upward for that netting set on the basis of a minimum holding period that is at least two times the minimum holding period for that netting set. (5)(i) A national bank or Federal savings association must adjust the supervisory haircuts upward on the basis of a holding period longer than ten business days for collateral associated with derivative contracts (five business days for client-facing derivative contracts) using the formula provided in paragraph (b)(2)(ii)(A)(6) of this section where the conditions in this paragraph (b)(2)(ii)(A)(5)(i) apply. For collateral associated with a derivative contract that is within a netting set that is composed of more than 5,000 derivative contracts that are not cleared transactions, a national bank or Federal savings association must use a minimum holding period of twenty PO 00000 Frm 00045 Fmt 4701 Sfmt 4702 30 31 32 33 New footnote number 31 32 33 34 business days. If a netting set contains one or more trades involving illiquid collateral or a derivative contract that cannot be easily replaced, a national bank or Federal savings association must use a minimum holding period of twenty business days. (ii) Notwithstanding paragraph (b)(2)(ii)(A)(1) or (3) or (b)(2)(ii)(A)(5)(i) of this section, for collateral associated with a derivative contract in a netting set under which more than two margin disputes that lasted longer than the holding period occurred during the previous two quarters, the minimum holding period is twice the amount provided under paragraph (b)(2)(ii)(A)(1) or (3) or (b)(2)(ii)(A)(5)(i) of this section. (6) A national bank or Federal savings association must adjust the standard supervisory haircuts upward, pursuant to the adjustments provided in paragraphs (b)(2)(ii)(A)(3) through (5) of this section, using the following formula: Where: TM equals a holding period of longer than 10 business days for eligible margin loans and derivative contracts other than client-facing derivative transactions or longer than 5 business days for repostyle transactions and client-facing derivative transactions; HS equals the standard supervisory haircut; and TS equals 10 business days for eligible margin loans and derivative contracts other than client-facing derivative transactions or 5 business days for repostyle transactions and client-facing derivative transactions. (7) If the instrument a national bank or Federal savings association has lent, sold subject to repurchase, or posted as collateral does not meet the definition of E:\FR\FM\24JAR2.SGM 24JAR2 ER24JA20.013</GPH> (HM) is calculated using the following square root of time formula: * * * * * (1) TM equals 5 for repo-style transactions and client-facing derivative transactions and 10 for eligible margin loans and derivative contracts other 4405 lotter on DSKBCFDHB2PROD with RULES2 4406 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations financial collateral, the national bank or Federal savings association must use a 25.0 percent haircut for market price volatility (HS). * * * * * (c) EAD for derivative contracts—(1) Options for determining EAD. A national bank or Federal savings association must determine the EAD for a derivative contract using the standardized approach for counterparty credit risk (SA–CCR) under paragraph (c)(5) of this section or using the internal models methodology described in paragraph (d) of this section. If a national bank or Federal savings association elects to use SA–CCR for one or more derivative contracts, the exposure amount determined under SA–CCR is the EAD for the derivative contract or derivative contracts. A national bank or Federal savings association must use the same methodology to calculate the exposure amount for all its derivative contracts and may change its election only with prior approval of the OCC. A national bank or Federal savings association may reduce the EAD calculated according to paragraph (c)(5) of this section by the credit valuation adjustment that the national bank or Federal savings association has recognized in its balance sheet valuation of any derivative contracts in the netting set. For purposes of this paragraph (c)(1), the credit valuation adjustment does not include any adjustments to common equity tier 1 capital attributable to changes in the fair value of the national bank’s or Federal savings association’s liabilities that are due to changes in its own credit risk since the inception of the transaction with the counterparty. (2) Definitions. For purposes of this paragraph (c) of this section, the following definitions apply: (i) End date means the last date of the period referenced by an interest rate or credit derivative contract or, if the derivative contract references another instrument, by the underlying instrument, except as otherwise provided in paragraph (c) of this section. (ii) Start date means the first date of the period referenced by an interest rate or credit derivative contract or, if the derivative contract references the value of another instrument, by underlying instrument, except as otherwise provided in paragraph (c) of this section. (iii) Hedging set means: (A) With respect to interest rate derivative contracts, all such contracts within a netting set that reference the same reference currency; VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 (B) With respect to exchange rate derivative contracts, all such contracts within a netting set that reference the same currency pair; (C) With respect to credit derivative contract, all such contracts within a netting set; (D) With respect to equity derivative contracts, all such contracts within a netting set; (E) With respect to a commodity derivative contract, all such contracts within a netting set that reference one of the following commodity categories: Energy, metal, agricultural, or other commodities; (F) With respect to basis derivative contracts, all such contracts within a netting set that reference the same pair of risk factors and are denominated in the same currency; or (G) With respect to volatility derivative contracts, all such contracts within a netting set that reference one of interest rate, exchange rate, credit, equity, or commodity risk factors, separated according to the requirements under paragraphs (c)(2)(iii)(A) through (E) of this section. (H) If the risk of a derivative contract materially depends on more than one of interest rate, exchange rate, credit, equity, or commodity risk factors, the OCC may require a national bank or Federal savings association to include the derivative contract in each appropriate hedging set under paragraphs (c)(2)(iii)(A) through (E) of this section. * * * * * (5) Exposure amount. (i) The exposure amount of a netting set, as calculated under paragraph (c) of this section, is equal to 1.4 multiplied by the sum of the replacement cost of the netting set, as calculated under paragraph (c)(6) of this section, and the potential future exposure of the netting set, as calculated under paragraph (c)(7) of this section. (ii) Notwithstanding the requirements of paragraph (c)(5)(i) of this section, the exposure amount of a netting set subject to a variation margin agreement, excluding a netting set that is subject to a variation margin agreement under which the counterparty to the variation margin agreement is not required to post variation margin, is equal to the lesser of the exposure amount of the netting set calculated under paragraph (c)(5)(i) of this section and the exposure amount of the netting set calculated as if the netting set were not subject to a variation margin agreement. (iii) Notwithstanding the requirements of paragraph (c)(5)(i) of this section, the exposure amount of a netting set that consists of only sold PO 00000 Frm 00046 Fmt 4701 Sfmt 4702 options in which the premiums have been fully paid by the counterparty to the options and where the options are not subject to a variation margin agreement is zero. (iv) Notwithstanding the requirements of paragraph (c)(5)(i) of this section, the exposure amount of a netting set in which the counterparty is a commercial end-user is equal to the sum of replacement cost, as calculated under paragraph (c)(6) of this section, and the potential future exposure of the netting set, as calculated under paragraph (c)(7) of this section. (v) For purposes of the exposure amount calculated under paragraph (c)(5)(i) of this section and all calculations that are part of that exposure amount, a national bank or Federal savings association may elect, at the netting set level, to treat a derivative contract that is a cleared transaction that is not subject to a variation margin agreement as one that is subject to a variation margin agreement, if the derivative contract is subject to a requirement that the counterparties make daily cash payments to each other to account for changes in the fair value of the derivative contract and to reduce the net position of the contract to zero. If a national bank or Federal savings association makes an election under this paragraph (c)(5)(v) for one derivative contract, it must treat all other derivative contracts within the same netting set that are eligible for an election under this paragraph (c)(5)(v) as derivative contracts that are subject to a variation margin agreement. (vi) For purposes of the exposure amount calculated under paragraph (c)(5)(i) of this section and all calculations that are part of that exposure amount, a national bank or Federal savings association may elect to treat a credit derivative contract, equity derivative contract, or commodity derivative contract that references an index as if it were multiple derivative contracts each referencing one component of the index. (6) Replacement cost of a netting set— (i) Netting set subject to a variation margin agreement under which the counterparty must post variation margin. The replacement cost of a netting set subject to a variation margin agreement, excluding a netting set that is subject to a variation margin agreement under which the counterparty is not required to post variation margin, is the greater of: (A) The sum of the fair values (after excluding any valuation adjustments) of the derivative contracts within the netting set less the sum of the net independent collateral amount and the E:\FR\FM\24JAR2.SGM 24JAR2 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations variation margin amount applicable to such derivative contracts; (B) The sum of the variation margin threshold and the minimum transfer amount applicable to the derivative contracts within the netting set less the net independent collateral amount applicable to such derivative contracts; or (C) Zero. (ii) Netting sets not subject to a variation margin agreement under which the counterparty must post variation margin. The replacement cost of a netting set that is not subject to a variation margin agreement under which the counterparty must post variation margin to the national bank or Federal savings association is the greater of: (A) The sum of the fair values (after excluding any valuation adjustments) of the derivative contracts within the netting set less the sum of the net independent collateral amount and variation margin amount applicable to such derivative contracts; or (B) Zero. (iii) Multiple netting sets subject to a single variation margin agreement. Notwithstanding paragraphs (c)(6)(i) and (ii) of this section, the replacement cost for multiple netting sets subject to a single variation margin agreement must be calculated according to paragraph (c)(10)(i) of this section. PFE multiplier= min { 1; 0.05 Where: V is the sum of the fair values (after excluding any valuation adjustments) of the derivative contracts within the netting set; C is the sum of the net independent collateral amount and the variation margin amount applicable to the derivative contracts within the netting set; and A is the aggregated amount of the netting set. (ii) Aggregated amount. The aggregated amount is the sum of all hedging set amounts, as calculated under paragraph (c)(8) of this section, within a netting set. = (iv) Netting set subject to multiple variation margin agreements or a hybrid netting set. Notwithstanding paragraphs (c)(6)(i) and (ii) of this section, the replacement cost for a netting set subject to multiple variation margin agreements or a hybrid netting set must be calculated according to paragraph (c)(11)(i) of this section. (7) Potential future exposure of a netting set. The potential future exposure of a netting set is the product of the PFE multiplier and the aggregated amount. (i) PFE multiplier. The PFE multiplier is calculated according to the following formula: + 0.95 * e(;;.~)} (iii) Multiple netting sets subject to a single variation margin agreement. Notwithstanding paragraphs (c)(7)(i) and (ii) of this section and when calculating the potential future exposure for purposes of total leverage exposure under § 3.10(c)(4)(ii)(B), the potential future exposure for multiple netting sets subject to a single variation margin agreement must be calculated according to paragraph (c)(10)(ii) of this section. (iv) Netting set subject to multiple variation margin agreements or a hybrid netting set. Notwithstanding paragraphs (c)(7)(i) and (ii) of this section and when calculating the potential future exposure Hedging set amount 4407 [(AddOn~i 1 )2 for purposes of total leverage exposure under § 3.10(c)(4)(ii)(B), the potential future exposure for a netting set subject to multiple variation margin agreements or a hybrid netting set must be calculated according to paragraph (c)(11)(ii) of this section. (8) Hedging set amount—(i) Interest rate derivative contracts. To calculate the hedging set amount of an interest rate derivative contract hedging set, a national bank or Federal savings association may use either of the formulas provided in paragraphs (c)(8)(i)(A) and (B) of this section: (A) Formula 1 is as follows: + (AddOn~i 2 ) 2 + 1 lotter on DSKBCFDHB2PROD with RULES2 (B) Formula 2 is as follows: Hedging set amount = |AddOnTB1IR| + |AddOnTB2IR| + |AddOnTB3IR|. Where in paragraphs (c)(8)(i)(A) and (B) of this section: AddOnTB1IR is the sum of the adjusted derivative contract amounts, as calculated under paragraph (c)(9) of this section, within the hedging set with an end date of less than one year from the present date; AddOnTB2IR is the sum of the adjusted derivative contract amounts, as VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 calculated under paragraph (c)(9) of this section, within the hedging set with an end date of one to five years from the present date; and AddOnTB3IR is the sum of the adjusted derivative contract amounts, as calculated under paragraph (c)(9) of this section, within the hedging set with an end date of more than five years from the present date. (ii) Exchange rate derivative contracts. For an exchange rate derivative contract hedging set, the PO 00000 Frm 00047 Fmt 4701 Sfmt 4702 hedging set amount equals the absolute value of the sum of the adjusted derivative contract amounts, as calculated under paragraph (c)(9) of this section, within the hedging set. (iii) Credit derivative contracts and equity derivative contracts. The hedging set amount of a credit derivative contract hedging set or equity derivative contract hedging set within a netting set is calculated according to the following formula: E:\FR\FM\24JAR2.SGM 24JAR2 ER24JA20.015</GPH> + 0.6 * AddOn~i 1 * Add0n~i 3 )]z; or ER24JA20.014</GPH> Add0n~i 3 4408 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 1 (Add0n(Refk)) 2 F Where: k is each reference entity within the hedging set. K is the number of reference entities within the hedging set. AddOn(Refk) equals the sum of the adjusted derivative contract amounts, as determined under paragraph (c)(9) of this section, for all derivative contracts within the hedging set that reference reference entity k. rk equals the applicable supervisory correlation factor, as provided in Table 2 to this section. (iv) Commodity derivative contracts. The hedging set amount of a commodity derivative contract hedging set within a netting set is calculated according to the following formula: Hedging set amount r 1 (v) Basis derivative contracts and volatility derivative contracts. Notwithstanding paragraphs (c)(8)(i) through (iv) of this section, a national bank or Federal savings association must calculate a separate hedging set amount for each basis derivative contract hedging set and each volatility derivative contract hedging set. A national bank or Federal savings association must calculate such hedging set amounts using one of the formulas under paragraphs (c)(8)(i) through (iv) of this section that corresponds to the primary risk factor of the hedging set being calculated. (9) Adjusted derivative contract amount—(i) Summary. To calculate the adjusted derivative contract amount of a derivative contract, a national bank or Federal savings association must determine the adjusted notional amount of derivative contract, pursuant to paragraph (c)(9)(ii) of this section, and multiply the adjusted notional amount Supervisory duration lotter on DSKBCFDHB2PROD with RULES2 Where: S is the number of business days from the present day until the start date of the derivative contract, or zero if the start date has already passed; and E is the number of business days from the present day until the end date of the derivative contract. (2) For purposes of paragraph (c)(9)(ii)(A)(1) of this section: (i) For an interest rate derivative contract or credit derivative contract that is a variable notional swap, the notional amount is equal to the timeweighted average of the contractual VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 2 = max { e -0.05* (;; 0 ) _ -0.05* ( 2~ 0 )) e Frm 00048 Fmt 4701 Sfmt 4702 } , 0.05 notional amounts of such a swap over the remaining life of the swap; and (ii) For an interest rate derivative contract or a credit derivative contract that is a leveraged swap, in which the notional amount of all legs of the derivative contract are divided by a factor and all rates of the derivative contract are multiplied by the same factor, the notional amount is equal to the notional amount of an equivalent unleveraged swap. (B)(1) For an exchange rate derivative contract, the adjusted notional amount is the notional amount of the non-U.S. denominated currency leg of the PO 00000 by each of the supervisory delta adjustment, pursuant to paragraph (c)(9)(iii) of this section, the maturity factor, pursuant to paragraph (c)(9)(iv) of this section, and the applicable supervisory factor, as provided in Table 2 to this section. (ii) Adjusted notional amount. (A)(1) For an interest rate derivative contract or a credit derivative contract, the adjusted notional amount equals the product of the notional amount of the derivative contract, as measured in U.S. dollars using the exchange rate on the date of the calculation, and the supervisory duration, as calculated by the following formula: 0.04 derivative contract, as measured in U.S. dollars using the exchange rate on the date of the calculation. If both legs of the exchange rate derivative contract are denominated in currencies other than U.S. dollars, the adjusted notional amount of the derivative contract is the largest leg of the derivative contract, as measured in U.S. dollars using the exchange rate on the date of the calculation. (2) Notwithstanding paragraph (c)(9)(ii)(B)(1) of this section, for an exchange rate derivative contract with multiple exchanges of principal, the national bank or Federal savings E:\FR\FM\24JAR2.SGM 24JAR2 ER24JA20.017</GPH> ER24JA20.018</GPH> Where: k is each commodity type within the hedging set. K is the number of commodity types within the hedging set. AddOn(Typek) equals the sum of the adjusted derivative contract amounts, as determined under paragraph (c)(9) of this section, for all derivative contracts within the hedging set that reference reference commodity type k. r equals the applicable supervisory correlation factor, as provided in Table 2 to this section. :z::=1(Add0n(Typek)) ER24JA20.016</GPH> * Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations association must set the adjusted notional amount of the derivative contract equal to the notional amount of the derivative contract multiplied by the number of exchanges of principal under the derivative contract. (C)(1) For an equity derivative contract or a commodity derivative contract, the adjusted notional amount is the product of the fair value of one unit of the reference instrument underlying the derivative contract and the number of such units referenced by the derivative contract. (2) Notwithstanding paragraph (c)(9)(ii)(C)(1) of this section, when calculating the adjusted notional amount for an equity derivative contract or a commodity derivative contract that is a volatility derivative contract, the national bank or Federal savings association must replace the unit price with the underlying volatility referenced by the volatility derivative contract and replace the number of units with the notional amount of the volatility derivative contract. (iii) Supervisory delta adjustments. (A) For a derivative contract that is not 4409 an option contract or collateralized debt obligation tranche, the supervisory delta adjustment is 1 if the fair value of the derivative contract increases when the value of the primary risk factor increases and ¥1 if the fair value of the derivative contract decreases when the value of the primary risk factor increases. (B)(1) For a derivative contract that is an option contract, the supervisory delta adjustment is determined by the following formulas, as applicable: Table 2 to §3.132--Supervisory Delta Adjustment for Options Contracts Boupt er'• T/250) _.(1n(: !~ )+O.S• er'• T/250) ·(1n(t !! )+o.s• Ji Put Options _.( 1n(~ a • JT /250 /250 H )+o.S• er'• T/250) ·( 1n(k !U +o.s • er' • T/250) a • a • JT /25fJ (2) As used in the formulas in Table 2 to this section: (i) F is the standard normal cumulative distribution function; (ii) P equals the current fair value of the instrument or risk factor, as applicable, underlying the option; (iii) K equals the strike price of the option; (iv) T equals the number of business days until the latest contractual exercise date of the option; (v) l equals zero for all derivative contracts except interest rate options for the currencies where interest rates have negative values. The same value of l must be used for all interest rate options that are denominated in the same currency. To determine the value of l for a given currency, a national bank or Federal savings association must find the lowest value L of P and K of all interest rate options in a given currency lotter on DSKBCFDHB2PROD with RULES2 Supervisory delta adjustment (2) As used in the formula in paragraph (c)(9)(iii)(C)(1) of this section: (i) A is the attachment point, which equals the ratio of the notional amounts of all underlying exposures that are subordinated to the national bank’s or Federal savings association’s exposure to the total notional amount of all underlying exposures, expressed as a decimal value between zero and one; 30 30 In the case of a first-to-default credit derivative, there are no underlying exposures that are subordinated to the national bank’s or Federal VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 savings association’s exposure. In the case of a second-or-subsequent-to-default credit derivative, the smallest (n¥1) notional amounts of the underlying exposures are subordinated to the national bank’s or Federal savings association’s exposure. Frm 00049 Fmt 4701 /250 that the national bank or Federal savings association has with all counterparties. Then, l is set according to this formula: l = max{¥L + 0.1%, 0}; and (vi) s equals the supervisory option volatility, as provided in Table 3 to of this section. (C)(1) For a derivative contract that is a collateralized debt obligation tranche, the supervisory delta adjustment is determined by the following formula: 15 =-(1 +14*A)*(1 +14*D) (ii) D is the detachment point, which equals one minus the ratio of the notional amounts of all underlying exposures that are senior to the national bank’s or Federal savings association’s exposure to the total notional amount of all underlying exposures, expressed as a PO 00000 JT Sfmt 4702 decimal value between zero and one; and (iii) The resulting amount is designated with a positive sign if the collateralized debt obligation tranche was purchased by the national bank or Federal savings association and is designated with a negative sign if the collateralized debt obligation tranche was sold by the national bank or Federal savings association. (iv) Maturity factor. (A)(1) The maturity factor of a derivative contract E:\FR\FM\24JAR2.SGM 24JAR2 ER24JA20.020</GPH> a • ER24JA20.019</GPH> Call 0plicms Sold Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations Maturity factor = ~2 ✓MPOR 250 Where MPOR refers to the period from the most recent exchange of collateral covering a netting set of derivative contracts with a defaulting counterparty until the derivative contracts are closed out and the resulting market risk is re-hedged. (2) Notwithstanding paragraph (c)(9)(iv)(A)(1) of this section: (i) For a derivative contract that is not a client-facing derivative transaction, MPOR cannot be less than ten business days plus the periodicity of remargining expressed in business days minus one business day; (ii) For a derivative contract that is a client-facing derivative transaction, MPOR cannot be less than five business days plus the periodicity of remargining expressed in business days minus one business day; and (iii) For a derivative contract that is within a netting set that is composed of more than 5,000 derivative contracts that are not cleared transactions, or a netting set that contains one or more trades involving illiquid collateral or a derivative contract that cannot be easily replaced, MPOR cannot be less than twenty business days. (3) Notwithstanding paragraphs (c)(9)(iv)(A)(1) and (2) of this section, for a netting set subject to two or more outstanding disputes over margin that lasted longer than the MPOR over the previous two quarters, the applicable floor is twice the amount provided in (c)(9)(iv)(A)(1) and (2) of this section. (B) The maturity factor of a derivative contract that is not subject to a variation margin agreement, or derivative contracts under which the counterparty is not required to post variation margin, is determined by the following formula: lotter on DSKBCFDHB2PROD with RULES2 Maturity factor = min{M;250} 250 Where M equals the greater of 10 business days and the remaining maturity of the contract, as measured in business days. (C) For purposes of paragraph (c)(9)(iv) of this section, if a national bank or Federal savings association has elected pursuant to paragraph (c)(5)(v) of this section to treat a derivative contract that is a cleared transaction that VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 is not subject to a variation margin agreement as one that is subject to a variation margin agreement, the national bank or Federal savings association must treat the derivative contract as subject to a variation margin agreement with maturity factor as determined according to (c)(9)(iv)(A) of this section, and daily settlement does not change the end date of the period referenced by the derivative contract. (v) Derivative contract as multiple effective derivative contracts. A national bank or Federal savings association must separate a derivative contract into separate derivative contracts, according to the following rules: (A) For an option where the counterparty pays a predetermined amount if the value of the underlying asset is above or below the strike price and nothing otherwise (binary option), the option must be treated as two separate options. For purposes of paragraph (c)(9)(iii)(B) of this section, a binary option with strike K must be represented as the combination of one bought European option and one sold European option of the same type as the original option (put or call) with the strikes set equal to 0.95 * K and 1.05 * K so that the payoff of the binary option is reproduced exactly outside the region between the two strikes. The absolute value of the sum of the adjusted derivative contract amounts of the bought and sold options is capped at the payoff amount of the binary option. (B) For a derivative contract that can be represented as a combination of standard option payoffs (such as collar, butterfly spread, calendar spread, straddle, and strangle), a national bank or Federal savings association must treat each standard option component as a separate derivative contract. (C) For a derivative contract that includes multiple-payment options, (such as interest rate caps and floors), a national bank or Federal savings association may represent each payment option as a combination of effective single-payment options (such as interest rate caplets and floorlets). (D) A national bank or Federal savings association may not decompose linear derivative contracts (such as swaps) into components. (10) Multiple netting sets subject to a single variation margin agreement—(i) Calculating replacement cost. Notwithstanding paragraph (c)(6) of this section, a national bank or Federal savings association shall assign a single replacement cost to multiple netting sets that are subject to a single variation margin agreement under which the counterparty must post variation PO 00000 Frm 00050 Fmt 4701 Sfmt 4702 margin, calculated according to the following formula: Replacement Cost = max{SNS max{VNS; 0} ¥ max{CMA; 0}; 0} + max{SNS min{VNS; 0} ¥ min{CMA; 0}; 0} Where: NS is each netting set subject to the variation margin agreement MA. VNS is the sum of the fair values (after excluding any valuation adjustments) of the derivative contracts within the netting set NS. CMA is the sum of the net independent collateral amount and the variation margin amount applicable to the derivative contracts within the netting sets subject to the single variation margin agreement. (ii) Calculating potential future exposure. Notwithstanding paragraph (c)(5) of this section, a national bank or Federal savings association shall assign a single potential future exposure to multiple netting sets that are subject to a single variation margin agreement under which the counterparty must post variation margin equal to the sum of the potential future exposure of each such netting set, each calculated according to paragraph (c)(7) of this section as if such nettings sets were not subject to a variation margin agreement. (11) Netting set subject to multiple variation margin agreements or a hybrid netting set—(i) Calculating replacement cost. To calculate replacement cost for either a netting set subject to multiple variation margin agreements under which the counterparty to each variation margin agreement must post variation margin, or a netting set composed of at least one derivative contract subject to variation margin agreement under which the counterparty must post variation margin and at least one derivative contract that is not subject to such a variation margin agreement, the calculation for replacement cost is provided under paragraph (c)(6)(i) of this section, except that the variation margin threshold equals the sum of the variation margin thresholds of all variation margin agreements within the netting set and the minimum transfer amount equals the sum of the minimum transfer amounts of all the variation margin agreements within the netting set. (ii) Calculating potential future exposure. (A) To calculate potential future exposure for a netting set subject to multiple variation margin agreements under which the counterparty to each variation margin agreement must post variation margin, or a netting set composed of at least one derivative contract subject to variation margin agreement under which the counterparty to the derivative contract E:\FR\FM\24JAR2.SGM 24JAR2 ER24JA20.022</GPH> that is subject to a variation margin agreement, excluding derivative contracts that are subject to a variation margin agreement under which the counterparty is not required to post variation margin, is determined by the following formula: ER24JA20.021</GPH> 4410 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations must post variation margin and at least one derivative contract that is not subject to such a variation margin agreement, a national bank or Federal savings association must divide the netting set into sub-netting sets (as described in paragraph (c)(11)(ii)(B) of this section) and calculate the aggregated amount for each sub-netting set. The aggregated amount for the netting set is calculated as the sum of the aggregated amounts for the subnetting sets. The multiplier is calculated for the entire netting set. (B) For purposes of paragraph (c)(11)(ii)(A) of this section, the netting set must be divided into sub-netting sets as follows: (1) All derivative contracts within the netting set that are not subject to a variation margin agreement or that are subject to a variation margin agreement under which the counterparty is not required to post variation margin form a single sub-netting set. The aggregated amount for this sub-netting set is calculated as if the netting set is not subject to a variation margin agreement. 4411 (2) All derivative contracts within the netting set that are subject to variation margin agreements in which the counterparty must post variation margin and that share the same value of the MPOR form a single sub-netting set. The aggregated amount for this sub-netting set is calculated as if the netting set is subject to a variation margin agreement, using the MPOR value shared by the derivative contracts within the netting set. TABLE 3 TO § 3.132—SUPERVISORY OPTION VOLATILITY, SUPERVISORY CORRELATION PARAMETERS, AND SUPERVISORY FACTORS FOR DERIVATIVE CONTRACTS Supervisory option volatility (percent) Asset class Category Type Interest rate ........................... Exchange rate ....................... Credit, single name ............... N/A ........................................ N/A ........................................ Investment grade .................. Speculative grade ................. Sub-speculative grade .......... Investment Grade ................. Speculative Grade ................ N/A ........................................ N/A ........................................ Energy ................................... N/A ........................................ N/A ........................................ N/A ........................................ N/A ........................................ N/A ........................................ N/A ........................................ N/A ........................................ N/A ........................................ N/A ........................................ Electricity ............................... Other ..................................... N/A ........................................ N/A ........................................ N/A ........................................ Credit, index .......................... Equity, single name .............. Equity, index ......................... Commodity ............................ Metals ................................... Agricultural ............................ Other ..................................... 50 15 100 100 100 80 80 120 75 150 70 70 70 70 Supervisory correlation factor (percent) N/A N/A 50 50 50 80 80 50 80 40 40 40 40 40 Supervisory factor 1 (percent) 0.50 4.0 0.46 1.3 6.0 0.38 1.06 32 20 40 18 18 18 18 lotter on DSKBCFDHB2PROD with RULES2 1 The applicable supervisory factor for basis derivative contract hedging sets is equal to one-half of the supervisory factor provided in this Table 3, and the applicable supervisory factor for volatility derivative contract hedging sets is equal to 5 times the supervisory factor provided in this Table 3. (d) * * * (10) * * * (i) With prior written approval of the OCC, a national bank or Federal savings association may set EAD equal to a measure of counterparty credit risk exposure, such as peak EAD, that is more conservative than an alpha of 1.4 times the larger of EPEunstressed and EPEstressed for every counterparty whose EAD will be measured under the alternative measure of counterparty exposure. The national bank or Federal savings association must demonstrate the conservatism of the measure of counterparty credit risk exposure used for EAD. With respect to paragraph (d)(10)(i) of this section: (A) For material portfolios of new OTC derivative products, the national bank or Federal savings association may assume that the standardized approach for counterparty credit risk pursuant to paragraph (c) of this section meets the conservatism requirement of this section for a period not to exceed 180 days. (B) For immaterial portfolios of OTC derivative contracts, the national bank or Federal savings association generally VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 may assume that the standardized approach for counterparty credit risk pursuant to paragraph (c) of this section meets the conservatism requirement of this section. * * * * * (e) * * * (6) * * * (viii) If a national bank or Federal savings association uses the standardized approach for counterparty credit risk pursuant to paragraph (c) of this section to calculate the EAD for any immaterial portfolios of OTC derivative contracts, the national bank or Federal savings association must use that EAD as a constant EE in the formula for the calculation of CVA with the maturity equal to the maximum of: (A) Half of the longest maturity of a transaction in the netting set; and (B) The notional weighted average maturity of all transactions in the netting set. 10. Section 3.133 is amended by revising paragraphs (a), (b)(1) through (3), (b)(4)(i), (c)(1) thorough (3), (c)(4)(i), and (d) to read as follows: PO 00000 Frm 00051 Fmt 4701 Sfmt 4702 § 3.133 Cleared transactions. (a) General requirements—(1) Clearing member clients. A national bank or Federal savings association that is a clearing member client must use the methodologies described in paragraph (b) of this section to calculate riskweighted assets for a cleared transaction. (2) Clearing members. A national bank or Federal savings association that is a clearing member must use the methodologies described in paragraph (c) of this section to calculate its riskweighted assets for a cleared transaction and paragraph (d) of this section to calculate its risk-weighted assets for its default fund contribution to a CCP. (b) * * * (1) Risk-weighted assets for cleared transactions. (i) To determine the riskweighted asset amount for a cleared transaction, a national bank or Federal savings association that is a clearing member client must multiply the trade exposure amount for the cleared transaction, calculated in accordance with paragraph (b)(2) of this section, by the risk weight appropriate for the E:\FR\FM\24JAR2.SGM 24JAR2 lotter on DSKBCFDHB2PROD with RULES2 4412 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations cleared transaction, determined in accordance with paragraph (b)(3) of this section. (ii) A clearing member client national bank’s or Federal savings association’s total risk-weighted assets for cleared transactions is the sum of the riskweighted asset amounts for all of its cleared transactions. (2) Trade exposure amount. (i) For a cleared transaction that is a derivative contract or a netting set of derivative contracts, trade exposure amount equals the EAD for the derivative contract or netting set of derivative contracts calculated using the methodology used to calculate EAD for derivative contracts set forth in § 3.132(c) or (d), plus the fair value of the collateral posted by the clearing member client national bank or Federal savings association and held by the CCP or a clearing member in a manner that is not bankruptcy remote. When the national bank or Federal savings association calculates EAD for the cleared transaction using the methodology in § 3.132(d), EAD equals EADunstressed. (ii) For a cleared transaction that is a repo-style transaction or netting set of repo-style transactions, trade exposure amount equals the EAD for the repostyle transaction calculated using the methodology set forth in § 3.132(b)(2) or (3) or (d), plus the fair value of the collateral posted by the clearing member client national bank or Federal savings association and held by the CCP or a clearing member in a manner that is not bankruptcy remote. When the national bank or Federal savings association calculates EAD for the cleared transaction under § 3.132(d), EAD equals EADunstressed. (3) Cleared transaction risk weights. (i) For a cleared transaction with a QCCP, a clearing member client national bank or Federal savings association must apply a risk weight of: (A) 2 percent if the collateral posted by the national bank or Federal savings association to the QCCP or clearing member is subject to an arrangement that prevents any loss to the clearing member client national bank or Federal savings association due to the joint default or a concurrent insolvency, liquidation, or receivership proceeding of the clearing member and any other clearing member clients of the clearing member; and the clearing member client national bank or Federal savings association has conducted sufficient legal review to conclude with a wellfounded basis (and maintains sufficient written documentation of that legal review) that in the event of a legal challenge (including one resulting from an event of default or from liquidation, VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 insolvency, or receivership proceedings) the relevant court and administrative authorities would find the arrangements to be legal, valid, binding, and enforceable under the law of the relevant jurisdictions. (B) 4 percent, if the requirements of paragraph (b)(3)(i)(A) of this section are not met. (ii) For a cleared transaction with a CCP that is not a QCCP, a clearing member client national bank or Federal savings association must apply the risk weight applicable to the CCP under subpart D of this part. (4) * * * (i) Notwithstanding any other requirement of this section, collateral posted by a clearing member client national bank or Federal savings association that is held by a custodian (in its capacity as a custodian) in a manner that is bankruptcy remote from the CCP, clearing member, and other clearing member clients of the clearing member, is not subject to a capital requirement under this section. * * * * * (c) * * * (1) Risk-weighted assets for cleared transactions. (i) To determine the riskweighted asset amount for a cleared transaction, a clearing member national bank or Federal savings association must multiply the trade exposure amount for the cleared transaction, calculated in accordance with paragraph (c)(2) of this section by the risk weight appropriate for the cleared transaction, determined in accordance with paragraph (c)(3) of this section. (ii) A clearing member national bank’s or Federal savings association’s total risk-weighted assets for cleared transactions is the sum of the riskweighted asset amounts for all of its cleared transactions. (2) Trade exposure amount. A clearing member national bank or Federal savings association must calculate its trade exposure amount for a cleared transaction as follows: (i) For a cleared transaction that is a derivative contract or a netting set of derivative contracts, trade exposure amount equals the EAD calculated using the methodology used to calculate EAD for derivative contracts set forth in § 3.132(c) or (d), plus the fair value of the collateral posted by the clearing member national bank or Federal savings association and held by the CCP in a manner that is not bankruptcy remote. When the clearing member national bank or Federal savings association calculates EAD for the cleared transaction using the methodology in § 3.132(d), EAD equals EADunstressed. PO 00000 Frm 00052 Fmt 4701 Sfmt 4702 (ii) For a cleared transaction that is a repo-style transaction or netting set of repo-style transactions, trade exposure amount equals the EAD calculated under § 3.132(b)(2) or (3) or (d), plus the fair value of the collateral posted by the clearing member national bank or Federal savings association and held by the CCP in a manner that is not bankruptcy remote. When the clearing member national bank or Federal savings association calculates EAD for the cleared transaction under § 3.132(d), EAD equals EADunstressed. (3) Cleared transaction risk weights. (i) A clearing member national bank or Federal savings association must apply a risk weight of 2 percent to the trade exposure amount for a cleared transaction with a QCCP. (ii) For a cleared transaction with a CCP that is not a QCCP, a clearing member national bank or Federal savings association must apply the risk weight applicable to the CCP according to subpart D of this part. (iii) Notwithstanding paragraphs (c)(3)(i) and (ii) of this section, a clearing member national bank or Federal savings association may apply a risk weight of zero percent to the trade exposure amount for a cleared transaction with a QCCP where the clearing member national bank or Federal savings association is acting as a financial intermediary on behalf of a clearing member client, the transaction offsets another transaction that satisfies the requirements set forth in § 3.3(a), and the clearing member national bank or Federal savings association is not obligated to reimburse the clearing member client in the event of the QCCP default. (4) * * * (i) Notwithstanding any other requirement of this section, collateral posted by a clearing member national bank or Federal savings association that is held by a custodian (in its capacity as a custodian) in a manner that is bankruptcy remote from the CCP, clearing member, and other clearing member clients of the clearing member, is not subject to a capital requirement under this section. * * * * * (d) Default fund contributions—(1) General requirement. A clearing member national bank or Federal savings association must determine the risk-weighted asset amount for a default fund contribution to a CCP at least quarterly, or more frequently if, in the opinion of the national bank or Federal savings association or the OCC, there is a material change in the financial condition of the CCP. E:\FR\FM\24JAR2.SGM 24JAR2 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations KcM = max{KccP * ( Where: KCCP is the hypothetical capital requirement of the QCCP, as determined under paragraph (d)(5) of this section; DFpref is the prefunded default fund contribution of the clearing member national bank or Federal savings association to the QCCP; DFCCP is the QCCP’s own prefunded amounts that are contributed to the default waterfall and are junior or pari passu with prefunded default fund contributions of clearing members of the CCP; and DFCMpref is the total prefunded default fund contributions from clearing members of the QCCP to the QCCP. (5) Hypothetical capital requirement of a QCCP. Where a QCCP has provided its KCCP, a national bank or Federal savings association must rely on such disclosed figure instead of calculating KCCP under this paragraph (d)(5), unless the national bank or Federal savings association determines that a more conservative figure is appropriate based on the nature, structure, or characteristics of the QCCP. The hypothetical capital requirement of a QCCP (KCCP), as determined by the national bank or Federal savings association, is equal to: KCCP = SCMi EADi * 1.6 percent lotter on DSKBCFDHB2PROD with RULES2 Where: CMi is each clearing member of the QCCP; and EADi is the exposure amount of each clearing member of the QCCP to the QCCP, as determined under paragraph (d)(6) of this section. (6) EAD of a clearing member national bank or Federal savings association to a QCCP. (i) The EAD of a clearing member national bank or Federal savings association to a QCCP is equal to the sum of the EAD for derivative contracts determined under paragraph (d)(6)(ii) of this section and the EAD for repo-style transactions determined under paragraph (d)(6)(iii) of this section. (ii) With respect to any derivative contracts between the national bank or VerDate Sep<11>2014 17:27 Jan 23, 2020 membership characteristics of the CCP and riskiness of its transactions, in cases where such default fund contributions may be unlimited. (3) Risk-weighted asset amount for default fund contributions to QCCPs. A clearing member national bank’s or Federal savings association’s riskweighted asset amount for default fund contributions to QCCPs equals the sum of its capital requirement, KCM for each Jkt 250001 DFpref pref ) ; D F CCP + D FCCPCM 0.16 percent* DFpref} Federal savings association and the CCP that are cleared transactions and any guarantees that the national bank or Federal savings association has provided to the CCP with respect to performance of a clearing member client on a derivative contract, the EAD is equal to the exposure amount for all such derivative contracts and guarantees of derivative contracts calculated under SA–CCR in § 3.132(c) (or, with respect to a CCP located outside the United States, under a substantially identical methodology in effect in the jurisdiction) using a value of 10 business days for purposes of § 3.132(c)(9)(iv); less the value of all collateral held by the CCP posted by the clearing member national bank or Federal savings association or a clearing member client of the national bank or Federal savings association in connection with a derivative contract for which the national bank or Federal savings association has provided a guarantee to the CCP and the amount of the prefunded default fund contribution of the national bank or Federal savings association to the CCP. (iii) With respect to any repo-style transactions between the national bank or Federal savings association and the CCP that are cleared transactions, EAD is equal to: EAD = max{EBRM ¥ IM ¥ DF; 0} Where: EBRM is the sum of the exposure amounts of each repo-style transaction between the national bank or Federal savings association and the CCP as determined under § 3.132(b)(2) and without recognition of any collateral securing the repo-style transactions; IM is the initial margin collateral posted by the national bank or Federal savings association to the CCP with respect to the repo-style transactions; and DF is the prefunded default fund contribution of the national bank or Federal savings association to the CCP that is not already deducted in paragraph (d)(6)(ii) of this section. PO 00000 Frm 00053 Fmt 4701 Sfmt 4702 QCCP, as calculated under the methodology set forth in paragraph (d)(4) of this section, multiplied by 12.5. (4) Capital requirement for default fund contributions to a QCCP. A clearing member national bank’s or Federal savings association’s capital requirement for its default fund contribution to a QCCP (KCM) is equal to: (iv) EAD must be calculated separately for each clearing member’s sub-client accounts and sub-house account (i.e., for the clearing member’s proprietary activities). If the clearing member’s collateral and its client’s collateral are held in the same default fund contribution account, then the EAD of that account is the sum of the EAD for the client-related transactions within the account and the EAD of the house-related transactions within the account. For purposes of determining such EADs, the independent collateral of the clearing member and its client must be allocated in proportion to the respective total amount of independent collateral posted by the clearing member to the QCCP. (v) If any account or sub-account contains both derivative contracts and repo-style transactions, the EAD of that account is the sum of the EAD for the derivative contracts within the account and the EAD of the repo-style transactions within the account. If independent collateral is held for an account containing both derivative contracts and repo-style transactions, then such collateral must be allocated to the derivative contracts and repo-style transactions in proportion to the respective product specific exposure amounts, calculated, excluding the effects of collateral, according to § 3.132(b) for repo-style transactions and to § 3.132(c)(5) for derivative contracts. (vi) Notwithstanding any other provision of paragraph (d) of this section, with the prior approval of the OCC, a national bank or Federal savings association may determine the riskweighted asset amount for a default fund contribution to a QCCP according to § 3.35(d)(3)(ii). 10. Section 3.173 is amended in Table 13 to § 3.173 by revising line 4 under Part 2, Derivative exposures, to read as follows: ■ E:\FR\FM\24JAR2.SGM 24JAR2 ER24JA20.023</GPH> (2) Risk-weighted asset amount for default fund contributions to nonqualifying CCPs. A clearing member national bank’s or Federal savings association’s risk-weighted asset amount for default fund contributions to CCPs that are not QCCPs equals the sum of such default fund contributions multiplied by 1,250 percent, or an amount determined by the OCC, based on factors such as size, structure, and 4413 4414 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations § 3.173 Disclosures by certain advanced approaches national banks or Federal savings associations and Category III national banks or Federal savings associations. * * * * * TABLE 13 TO § 3.173—SUPPLEMENTARY LEVERAGE RATIO Dollar amounts in thousands Tril * * * * Bil Mil Thou * * * * * * * * * * * * Part 2: Supplementary leverage ratio * * * * Derivative exposures * * * * 4 Current exposure for derivative exposures (that is, net of cash variation margin). * * * 11. Section 3.300 is amended by adding paragraphs (g) and (h) to read as follows: ■ § 3.300 Transitions. lotter on DSKBCFDHB2PROD with RULES2 * * * * * (g) SA–CCR. An advanced approaches national bank or Federal savings association may use CEM rather than SA–CCR for purposes of §§ 3.34(a) and 3.132(c) until January 1, 2022. An advanced approaches national bank or Federal savings association must provide prior notice to the OCC if it decides to begin using SA–CCR before January 1, 2022. On January 1, 2022, and thereafter, an advanced approaches national bank or Federal savings association must use SA–CCR for purposes of §§ 3.34(a), 3.132(c), and 3.133(d). Once an advanced approaches national bank or Federal savings association has begun to use SA–CCR, the advanced approaches national bank or Federal savings association may not change to use CEM. (h) Default fund contributions. Prior to January 1, 2022, a national bank or Federal savings association that calculates the exposure amounts of its derivative contracts under the standardized approach for counterparty credit risk in § 3.132(c) may calculate the risk-weighted asset amount for a default fund contribution to a QCCP under either method 1 under § 3.35(d)(3)(i) or method 2 under § 3.35(d)(3)(ii), rather than under § 3.133(d). VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 * FEDERAL RESERVE SYSTEM PART 32—LENDING LIMITS 12. The authority citation for part 32 continues to read as follows: ■ Authority: 12 U.S.C. 1 et seq., 12 U.S.C. 84, 93a, 1462a, 1463, 1464(u), 5412(b)(2)(B), and 15 U.S.C. 1639h. 13. Section 32.9 is amended by revising paragraph (b)(1)(iii) and adding paragraph (b)(1)(iv) to read as follows: ■ § 32.9 Credit exposure arising from derivative and securities financing transactions. * * * * * (b) * * * (1) * * * (iii) Current Exposure Method. The credit exposure arising from a derivative transaction (other than a credit derivative transaction) under the Current Exposure Method shall be calculated pursuant to 12 CFR 3.34(b)(1) and (2) and (c) or 324.34(b)(1) and (2) and (c), as appropriate. (iv) Standardized Approach for Counterparty Credit Risk Method. The credit exposure arising from a derivative transaction (other than a credit derivative transaction) under the Standardized Approach for Counterparty Credit Risk Method shall be calculated pursuant to 12 CFR 3.132(c)(5) or 324.132(c)(5), as appropriate. * * * * * PO 00000 Frm 00054 Fmt 4701 Sfmt 4702 12 CFR Chapter II Authority and Issuance For the reasons set forth in the preamble, chapter II of title 12 of the Code of Federal Regulations is amended as set forth below: PART 217—CAPITAL ADEQUACY OF BANK HOLDING COMPANIES, SAVINGS AND LOAN HOLDING COMPANIES, AND STATE MEMBER BANKS (REGULATION Q) 14. The authority citation for part 217 continues to read as follows: ■ Authority: 12 U.S.C. 248(a), 321–338a, 481–486, 1462a, 1467a, 1818, 1828, 1831n, 1831o, 1831p–l, 1831w, 1835, 1844(b), 1851, 3904, 3906–3909, 4808, 5365, 5368, 5371, and 5371 note. 15. Section 217.2 is amended by: a. Adding the definitions of ‘‘Basis derivative contract,’’ ‘‘Client-facing derivative transaction,’’ and ‘‘Commercial end-user’’ in alphabetical order; ■ b. Revising the definitions of ‘‘Current exposure’’ and ‘‘Current exposure methodology;’’ ■ c. Revising paragraph (2) of the definition of ‘‘Financial collateral;’’ ■ d. Adding the definitions of ‘‘Independent collateral,’’ ‘‘Minimum transfer amount,’’ and ‘‘Net independent collateral amount’’ in alphabetical order; ■ e. Revising the definition of ‘‘Netting set;’’ and ■ ■ E:\FR\FM\24JAR2.SGM 24JAR2 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations f. Adding the definitions of ‘‘Speculative grade,’’ ‘‘Sub-speculative grade,’’ ‘‘Variation margin,’’ ‘‘Variation margin agreement,’’ ‘‘Variation margin amount,’’ ‘‘Variation margin threshold,’’ and ‘‘Volatility derivative contract’’ in alphabetical order. The additions and revisions read as follows: ■ § 217.2 Definitions. lotter on DSKBCFDHB2PROD with RULES2 * * * * * Basis derivative contract means a nonforeign-exchange derivative contract (i.e., the contract is denominated in a single currency) in which the cash flows of the derivative contract depend on the difference between two risk factors that are attributable solely to one of the following derivative asset classes: Interest rate, credit, equity, or commodity. * * * * * Client-facing derivative transaction means a derivative contract that is not a cleared transaction where the Boardregulated institution is either acting as a financial intermediary and enters into an offsetting transaction with a qualifying central counterparty (QCCP) or where the Board-regulated institution provides a guarantee on the performance of a client on a transaction between the client and a QCCP. * * * * * Commercial end-user means an entity that: (1)(i) Is using derivative contracts to hedge or mitigate commercial risk; and (ii)(A) Is not an entity described in section 2(h)(7)(C)(i)(I) through (VIII) of the Commodity Exchange Act (7 U.S.C. 2(h)(7)(C)(i)(I) through (VIII)); or (B) Is not a ‘‘financial entity’’ for purposes of section 2(h)(7) of the Commodity Exchange Act (7 U.S.C. 2(h)) by virtue of section 2(h)(7)(C)(iii) of the Act (7 U.S.C. 2(h)(7)(C)(iii)); or (2)(i) Is using derivative contracts to hedge or mitigate commercial risk; and (ii) Is not an entity described in section 3C(g)(3)(A)(i) through (viii) of the Securities Exchange Act of 1934 (15 U.S.C. 78c–3(g)(3)(A)(i) through (viii)); or (3) Qualifies for the exemption in section 2(h)(7)(A) of the Commodity Exchange Act (7 U.S.C. 2(h)(7)(A)) by virtue of section 2(h)(7)(D) of the Act (7 U.S.C. 2(h)(7)(D)); or (4) Qualifies for an exemption in section 3C(g)(1) of the Securities Exchange Act of 1934 (15 U.S.C. 78c– 3(g)(1)) by virtue of section 3C(g)(4) of the Act (15 U.S.C. 78c–3(g)(4)). * * * * * Current exposure means, with respect to a netting set, the larger of zero or the VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 fair value of a transaction or portfolio of transactions within the netting set that would be lost upon default of the counterparty, assuming no recovery on the value of the transactions. Current exposure methodology means the method of calculating the exposure amount for over-the-counter derivative contracts in § 217.34(b). * * * * * Financial collateral * * * (2) In which the Board-regulated institution has a perfected, first-priority security interest or, outside of the United States, the legal equivalent thereof, (with the exception of cash on deposit; and notwithstanding the prior security interest of any custodial agent or any priority security interest granted to a CCP in connection with collateral posted to that CCP). * * * * * Independent collateral means financial collateral, other than variation margin, that is subject to a collateral agreement, or in which a Boardregulated institution has a perfected, first-priority security interest or, outside of the United States, the legal equivalent thereof (with the exception of cash on deposit; notwithstanding the prior security interest of any custodial agent or any prior security interest granted to a CCP in connection with collateral posted to that CCP), and the amount of which does not change directly in response to the value of the derivative contract or contracts that the financial collateral secures. * * * * * Minimum transfer amount means the smallest amount of variation margin that may be transferred between counterparties to a netting set pursuant to the variation margin agreement. * * * * * Net independent collateral amount means the fair value amount of the independent collateral, as adjusted by the standard supervisory haircuts under § 217.132(b)(2)(ii), as applicable, that a counterparty to a netting set has posted to a Board-regulated institution less the fair value amount of the independent collateral, as adjusted by the standard supervisory haircuts under § 217.132(b)(2)(ii), as applicable, posted by the Board-regulated institution to the counterparty, excluding such amounts held in a bankruptcy remote manner or posted to a QCCP and held in conformance with the operational requirements in § 217.3. Netting set means a group of transactions with a single counterparty that are subject to a qualifying master netting agreement. For derivative contracts, netting set also includes a PO 00000 Frm 00055 Fmt 4701 Sfmt 4702 4415 single derivative contract between a Board-regulated institution and a single counterparty. For purposes of the internal model methodology under § 217.132(d), netting set also includes a group of transactions with a single counterparty that are subject to a qualifying cross-product master netting agreement and does not include a transaction: (1) That is not subject to such a master netting agreement; or (2) Where the Board-regulated institution has identified specific wrong-way risk. * * * * * Speculative grade means the reference entity has adequate capacity to meet financial commitments in the near term, but is vulnerable to adverse economic conditions, such that should economic conditions deteriorate, the reference entity would present an elevated default risk. * * * * * Sub-speculative grade means the reference entity depends on favorable economic conditions to meet its financial commitments, such that should such economic conditions deteriorate the reference entity likely would default on its financial commitments. * * * * * Variation margin means financial collateral that is subject to a collateral agreement provided by one party to its counterparty to meet the performance of the first party’s obligations under one or more transactions between the parties as a result of a change in value of such obligations since the last time such financial collateral was provided. Variation margin agreement means an agreement to collect or post variation margin. Variation margin amount means the fair value amount of the variation margin, as adjusted by the standard supervisory haircuts under § 217.132(b)(2)(ii), as applicable, that a counterparty to a netting set has posted to a Board-regulated institution less the fair value amount of the variation margin, as adjusted by the standard supervisory haircuts under § 217.132(b)(2)(ii), as applicable, posted by the Board-regulated institution to the counterparty. Variation margin threshold means the amount of credit exposure of a Boardregulated institution to its counterparty that, if exceeded, would require the counterparty to post variation margin to the Board-regulated institution pursuant to the variation margin agreement. Volatility derivative contract means a derivative contract in which the payoff E:\FR\FM\24JAR2.SGM 24JAR2 4416 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations of the derivative contract explicitly depends on a measure of the volatility of an underlying risk factor to the derivative contract. * * * * * ■ 16. Section 217.10 is amended by revising paragraphs (c)(4)(ii)(A) through (C) to read as follows: § 217.10 Minimum capital requirements. lotter on DSKBCFDHB2PROD with RULES2 * * * * * (c) * * * (4) * * * (ii) * * * (A) The balance sheet carrying value of all of the Board-regulated institution’s on-balance sheet assets, plus the value of securities sold under a repurchase transaction or a securities lending transaction that qualifies for sales treatment under U.S. GAAP, less amounts deducted from tier 1 capital under § 217.22(a), (c), and (d), and less the value of securities received in security-for-security repo-style transactions, where the Board-regulated institution acts as a securities lender and includes the securities received in its on-balance sheet assets but has not sold or re-hypothecated the securities received, and, for a Board-regulated institution that uses the standardized approach for counterparty credit risk under § 217.132(c) for its standardized risk-weighted assets, less the fair value of any derivative contracts; (B)(1) For a Board-regulated institution that uses the current exposure methodology under § 217.34(b) for its standardized riskweighted assets, the potential future credit exposure (PFE) for each derivative contract or each singleproduct netting set of derivative contracts (including a cleared transaction except as provided in paragraph (c)(4)(ii)(I) of this section and, at the discretion of the Board-regulated institution, excluding a forward agreement treated as a derivative contract that is part of a repurchase or reverse repurchase or a securities borrowing or lending transaction that qualifies for sales treatment under U.S. GAAP), to which the Board-regulated institution is a counterparty as determined under § 217.34, but without regard to § 217.34(b), provided that: (i) A Board-regulated institution may choose to exclude the PFE of all credit derivatives or other similar instruments through which it provides credit protection when calculating the PFE under § 217.34, but without regard to § 217.34(b), provided that it does not adjust the net-to-gross ratio (NGR); and (ii) A Board-regulated institution that chooses to exclude the PFE of credit VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 derivatives or other similar instruments through which it provides credit protection pursuant to paragraph (c)(4)(ii)(B)(1) of this section must do so consistently over time for the calculation of the PFE for all such instruments; or (2)(i) For a Board-regulated institution that uses the standardized approach for counterparty credit risk under section § 217.132(c) for its standardized riskweighted assets, the PFE for each netting set to which the Board-regulated institution is a counterparty (including cleared transactions except as provided in paragraph (c)(4)(ii)(I) of this section and, at the discretion of the Boardregulated institution, excluding a forward agreement treated as a derivative contract that is part of a repurchase or reverse repurchase or a securities borrowing or lending transaction that qualifies for sales treatment under U.S. GAAP), as determined under § 217.132(c)(7), in which the term C in § 217.132(c)(7)(i) equals zero except as provided in paragraph (c)(4)(ii)(B)(2)(ii) of this section, and, for any counterparty that is not a commercial end-user, multiplied by 1.4; and (ii) For purposes of paragraph (c)(4)(ii)(B)(2)(i) of this section, a Boardregulated institution may set the value of the term C in § 217.132(c)(7)(i) equal to the amount of collateral posted by a clearing member client of the Boardregulated institution in connection with the client-facing derivative transactions within the netting set; (C)(1)(i) For a Board-regulated institution that uses the current exposure methodology under § 217.34(b) for its standardized riskweighted assets, the amount of cash collateral that is received from a counterparty to a derivative contract and that has offset the mark-to-fair value of the derivative asset, or cash collateral that is posted to a counterparty to a derivative contract and that has reduced the Board-regulated institution’s onbalance sheet assets, unless such cash collateral is all or part of variation margin that satisfies the conditions in paragraphs (c)(4)(ii)(C)(3) through (7) of this section; and (ii) The variation margin is used to reduce the current credit exposure of the derivative contract, calculated as described in § 217.34(b), and not the PFE; and (iii) For the purpose of the calculation of the NGR described in § 217.34(b)(2)(ii)(B), variation margin described in paragraph (c)(4)(ii)(C)(1)(ii) of this section may not reduce the net current credit exposure or the gross current credit exposure; or PO 00000 Frm 00056 Fmt 4701 Sfmt 4702 (2)(i) For a Board-regulated institution that uses the standardized approach for counterparty credit risk under § 217.132(c) for its standardized riskweighted assets, the replacement cost of each derivative contract or single product netting set of derivative contracts to which the Board-regulated institution is a counterparty, calculated according to the following formula, and, for any counterparty that is not a commercial end-user, multiplied by 1.4: Replacement Cost = max{V¥CVMr + CVMp; 0} Where: V equals the fair value for each derivative contract or each single-product netting set of derivative contracts (including a cleared transaction except as provided in paragraph (c)(4)(ii)(I) of this section and, at the discretion of the Board-regulated institution, excluding a forward agreement treated as a derivative contract that is part of a repurchase or reverse repurchase or a securities borrowing or lending transaction that qualifies for sales treatment under U.S. GAAP); CVMr equals the amount of cash collateral received from a counterparty to a derivative contract and that satisfies the conditions in paragraphs (c)(4)(ii)(C)(3) through (7) of this section, or, in the case of a client-facing derivative transaction, the amount of collateral received from the clearing member client; and CVMp equals the amount of cash collateral that is posted to a counterparty to a derivative contract and that has not offset the fair value of the derivative contract and that satisfies the conditions in paragraphs (c)(4)(ii)(C)(3) through (7) of this section, or, in the case of a clientfacing derivative transaction, the amount of collateral posted to the clearing member client; (ii) Notwithstanding paragraph (c)(4)(ii)(C)(2)(i) of this section, where multiple netting sets are subject to a single variation margin agreement, a Board-regulated institution must apply the formula for replacement cost provided in § 217.132(c)(10)(i), in which the term CMA may only include cash collateral that satisfies the conditions in paragraphs (c)(4)(ii)(C)(3) through (7) of this section; and (iii) For purposes of paragraph (c)(4)(ii)(C)(2)(i), a Board-regulated institution must treat a derivative contract that references an index as if it were multiple derivative contracts each referencing one component of the index if the Board-regulated institution elected to treat the derivative contract as multiple derivative contracts under § 217.132(c)(5)(vi); (3) For derivative contracts that are not cleared through a QCCP, the cash collateral received by the recipient counterparty is not segregated (by law, E:\FR\FM\24JAR2.SGM 24JAR2 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations regulation, or an agreement with the counterparty); (4) Variation margin is calculated and transferred on a daily basis based on the mark-to-fair value of the derivative contract; (5) The variation margin transferred under the derivative contract or the governing rules of the CCP or QCCP for a cleared transaction is the full amount that is necessary to fully extinguish the net current credit exposure to the counterparty of the derivative contracts, subject to the threshold and minimum transfer amounts applicable to the counterparty under the terms of the derivative contract or the governing rules for a cleared transaction; (6) The variation margin is in the form of cash in the same currency as the currency of settlement set forth in the derivative contract, provided that for the purposes of this paragraph (c)(4)(ii)(C)(6), currency of settlement means any currency for settlement specified in the governing qualifying master netting agreement and the credit support annex to the qualifying master netting agreement, or in the governing rules for a cleared transaction; and (7) The derivative contract and the variation margin are governed by a qualifying master netting agreement between the legal entities that are the counterparties to the derivative contract or by the governing rules for a cleared transaction, and the qualifying master netting agreement or the governing rules for a cleared transaction must explicitly stipulate that the counterparties agree to settle any payment obligations on a net basis, taking into account any variation margin received or provided under the contract if a credit event involving either counterparty occurs; * * * * * ■ 17. Section 217.32 is amended by revising paragraph (f) to read as follows: § 217.32 General risk weights. lotter on DSKBCFDHB2PROD with RULES2 * * * * * (f) Corporate exposures. (1) A Boardregulated institution must assign a 100 percent risk weight to all its corporate exposures, except as provided in paragraph (f)(2) of this section. (2) A Board-regulated institution must assign a 2 percent risk weight to an exposure to a QCCP arising from the Board-regulated institution posting cash collateral to the QCCP in connection with a cleared transaction that meets the requirements of § 217.35(b)(3)(i)(A) and a 4 percent risk weight to an exposure to a QCCP arising from the Board- VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 regulated institution posting cash collateral to the QCCP in connection with a cleared transaction that meets the requirements of § 217.35(b)(3)(i)(B). (3) A Board-regulated institution must assign a 2 percent risk weight to an exposure to a QCCP arising from the Board-regulated institution posting cash collateral to the QCCP in connection with a cleared transaction that meets the requirements of § 217.35(c)(3)(i). * * * * * ■ 18. Section 217.34 is revised to read as follows: § 217.34 Derivative contracts. (a) Exposure amount for derivative contracts—(1) Board-regulated institution that is not an advanced approaches Board-regulated institution. (i) A Board-regulated institution that is not an advanced approaches Boardregulated institution must use the current exposure methodology (CEM) described in paragraph (b) of this section to calculate the exposure amount for all its OTC derivative contracts, unless the Board-regulated institution makes the election provided in paragraph (a)(1)(ii) of this section. (ii) A Board-regulated institution that is not an advanced approaches Boardregulated institution may elect to calculate the exposure amount for all its OTC derivative contracts under the standardized approach for counterparty credit risk (SA–CCR) in § 217.132(c) by notifying the Board, rather than calculating the exposure amount for all its derivative contracts using CEM. A Board-regulated institution that elects under this paragraph (a)(1)(ii) to calculate the exposure amount for its OTC derivative contracts under SA–CCR must apply the treatment of cleared transactions under § 217.133 to its derivative contracts that are cleared transactions and to all default fund contributions associated with such derivative contracts, rather than applying § 217.35. A Board-regulated institution that is not an advanced approaches Board-regulated institution must use the same methodology to calculate the exposure amount for all its derivative contracts and, if a Boardregulated institution has elected to use SA–CCR under this paragraph (a)(1)(ii), the Board-regulated institution may change its election only with prior approval of the Board. (2) Advanced approaches Boardregulated institution. An advanced approaches Board-regulated institution must calculate the exposure amount for PO 00000 Frm 00057 Fmt 4701 Sfmt 4702 4417 all its derivative contracts using SA– CCR in § 217.132(c) for purposes of standardized total risk-weighted assets. An advanced approaches Boardregulated institution must apply the treatment of cleared transactions under § 217.133 to its derivative contracts that are cleared transactions and to all default fund contributions associated with such derivative contracts for purposes of standardized total riskweighted assets. (b) Current exposure methodology exposure amount—(1) Single OTC derivative contract. Except as modified by paragraph (c) of this section, the exposure amount for a single OTC derivative contract that is not subject to a qualifying master netting agreement is equal to the sum of the Board-regulated institution’s current credit exposure and potential future credit exposure (PFE) on the OTC derivative contract. (i) Current credit exposure. The current credit exposure for a single OTC derivative contract is the greater of the fair value of the OTC derivative contract or zero. (ii) PFE. (A) The PFE for a single OTC derivative contract, including an OTC derivative contract with a negative fair value, is calculated by multiplying the notional principal amount of the OTC derivative contract by the appropriate conversion factor in Table 1 to this section. (B) For purposes of calculating either the PFE under this paragraph (b)(1)(ii) or the gross PFE under paragraph (b)(2)(ii)(A) of this section for exchange rate contracts and other similar contracts in which the notional principal amount is equivalent to the cash flows, notional principal amount is the net receipts to each party falling due on each value date in each currency. (C) For an OTC derivative contract that does not fall within one of the specified categories in Table 1 to this section, the PFE must be calculated using the appropriate ‘‘other’’ conversion factor. (D) A Board-regulated institution must use an OTC derivative contract’s effective notional principal amount (that is, the apparent or stated notional principal amount multiplied by any multiplier in the OTC derivative contract) rather than the apparent or stated notional principal amount in calculating PFE. (E) The PFE of the protection provider of a credit derivative is capped at the net present value of the amount of unpaid premiums. E:\FR\FM\24JAR2.SGM 24JAR2 4418 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations TABLE 1 TO § 217.34—CONVERSION FACTOR MATRIX FOR DERIVATIVE CONTRACTS 1 Remaining maturity 2 Foreign exchange rate and gold Interest rate One year or less ........................................... Greater than one year and less than or equal to five years ..................................... Greater than five years ................................. Credit (noninvestmentgrade reference asset) Credit (investment grade reference asset) 3 Precious metals (except gold) Equity Other 0.00 0.01 0.05 0.10 0.06 0.07 0.10 0.005 0.015 0.05 0.075 0.05 0.05 0.10 0.10 0.08 0.10 0.07 0.08 0.12 0.15 1 For a derivative contract with multiple exchanges of principal, the conversion factor is multiplied by the number of remaining payments in the derivative contract. an OTC derivative contract that is structured such that on specified dates any outstanding exposure is settled and the terms are reset so that the fair value of the contract is zero, the remaining maturity equals the time until the next reset date. For an interest rate derivative contract with a remaining maturity of greater than one year that meets these criteria, the minimum conversion factor is 0.005. 3 A Board-regulated institution must use the column labeled ‘‘Credit (investment-grade reference asset)’’ for a credit derivative whose reference asset is an outstanding unsecured long-term debt security without credit enhancement that is investment grade. A Board-regulated institution must use the column labeled ‘‘Credit (non-investment-grade reference asset)’’ for all other credit derivatives. lotter on DSKBCFDHB2PROD with RULES2 2 For (2) Multiple OTC derivative contracts subject to a qualifying master netting agreement. Except as modified by paragraph (c) of this section, the exposure amount for multiple OTC derivative contracts subject to a qualifying master netting agreement is equal to the sum of the net current credit exposure and the adjusted sum of the PFE amounts for all OTC derivative contracts subject to the qualifying master netting agreement. (i) Net current credit exposure. The net current credit exposure is the greater of the net sum of all positive and negative fair values of the individual OTC derivative contracts subject to the qualifying master netting agreement or zero. (ii) Adjusted sum of the PFE amounts. The adjusted sum of the PFE amounts, Anet, is calculated as Anet = (0.4 × Agross) + (0.6 × NGR × Agross), where: (A) Agross = the gross PFE (that is, the sum of the PFE amounts as determined under paragraph (b)(1)(ii) of this section for each individual derivative contract subject to the qualifying master netting agreement); and (B) Net-to-gross Ratio (NGR) = the ratio of the net current credit exposure to the gross current credit exposure. In calculating the NGR, the gross current credit exposure equals the sum of the positive current credit exposures (as determined under paragraph (b)(1)(i) of this section) of all individual derivative contracts subject to the qualifying master netting agreement. (c) Recognition of credit risk mitigation of collateralized OTC derivative contracts. (1) A Boardregulated institution using CEM under paragraph (b) of this section may recognize the credit risk mitigation benefits of financial collateral that secures an OTC derivative contract or multiple OTC derivative contracts subject to a qualifying master netting agreement (netting set) by using the simple approach in § 217.37(b). VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 (2) As an alternative to the simple approach, a Board-regulated institution using CEM under paragraph (b) of this section may recognize the credit risk mitigation benefits of financial collateral that secures such a contract or netting set if the financial collateral is markedto-fair value on a daily basis and subject to a daily margin maintenance requirement by applying a risk weight to the uncollateralized portion of the exposure, after adjusting the exposure amount calculated under paragraph (b)(1) or (2) of this section using the collateral haircut approach in § 217.37(c). The Board-regulated institution must substitute the exposure amount calculated under paragraph (b)(1) or (2) of this section for SE in the equation in § 217.37(c)(2). (d) Counterparty credit risk for credit derivatives—(1) Protection purchasers. A Board-regulated institution that purchases a credit derivative that is recognized under § 217.36 as a credit risk mitigant for an exposure that is not a covered position under subpart F of this part is not required to compute a separate counterparty credit risk capital requirement under this subpart provided that the Board-regulated institution does so consistently for all such credit derivatives. The Boardregulated institution must either include all or exclude all such credit derivatives that are subject to a qualifying master netting agreement from any measure used to determine counterparty credit risk exposure to all relevant counterparties for risk-based capital purposes. (2) Protection providers. (i) A Boardregulated institution that is the protection provider under a credit derivative must treat the credit derivative as an exposure to the underlying reference asset. The Boardregulated institution is not required to compute a counterparty credit risk capital requirement for the credit derivative under this subpart, provided PO 00000 Frm 00058 Fmt 4701 Sfmt 4702 that this treatment is applied consistently for all such credit derivatives. The Board-regulated institution must either include all or exclude all such credit derivatives that are subject to a qualifying master netting agreement from any measure used to determine counterparty credit risk exposure. (ii) The provisions of this paragraph (d)(2) apply to all relevant counterparties for risk-based capital purposes unless the Board-regulated institution is treating the credit derivative as a covered position under subpart F of this part, in which case the Board-regulated institution must compute a supplemental counterparty credit risk capital requirement under this section. (e) Counterparty credit risk for equity derivatives. (1) A Board-regulated institution must treat an equity derivative contract as an equity exposure and compute a risk-weighted asset amount for the equity derivative contract under §§ 217.51 through 217.53 (unless the Board-regulated institution is treating the contract as a covered position under subpart F of this part). (2) In addition, the Board-regulated institution must also calculate a riskbased capital requirement for the counterparty credit risk of an equity derivative contract under this section if the Board-regulated institution is treating the contract as a covered position under subpart F of this part. (3) If the Board-regulated institution risk weights the contract under the Simple Risk-Weight Approach (SRWA) in § 217.52, the Board-regulated institution may choose not to hold riskbased capital against the counterparty credit risk of the equity derivative contract, as long as it does so for all such contracts. Where the equity derivative contracts are subject to a qualified master netting agreement, a Board-regulated institution using the SRWA must either include all or E:\FR\FM\24JAR2.SGM 24JAR2 4419 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations Scaling factor = /H ✓w Where H = the holding period greater than or equal to five days. Additionally, the Board may require the Board-regulated institution to set a longer holding period if the Board determines that a longer period is appropriate due to the nature, structure, or characteristics of the transaction or is commensurate with the risks associated with the transaction. ■ 19. Section 217.35 is amended by adding paragraph (a)(3), revising paragraph (b)(4)(i), and adding paragraph (c)(3)(iii) to read as follows: § 217.35 (b) * * * (4) * * * (i) Notwithstanding any other requirements in this section, collateral posted by a clearing member client Board-regulated institution that is held by a custodian (in its capacity as custodian) in a manner that is bankruptcy remote from the CCP, clearing member, and other clearing member clients of the clearing member, is not subject to a capital requirement under this section. * * * * * (c) * * * (3) * * * (iii) Notwithstanding paragraphs (c)(3)(i) and (ii) of this section, a clearing member Board-regulated institution may apply a risk weight of zero percent to the trade exposure amount for a cleared transaction with a CCP where the clearing member Boardregulated institution is acting as a financial intermediary on behalf of a clearing member client, the transaction offsets another transaction that satisfies the requirements set forth in § 217.3(a), and the clearing member Boardregulated institution is not obligated to reimburse the clearing member client in the event of the CCP default. * * * * * ■ 20. Section 217.37 is amended by revising paragraphs (c)(3)(iii), (c)(3)(iv)(A) and (C), (c)(4)(i)(B) introductory text, and (c)(4)(i)(B)(1) to read as follows: § 217.37 Collateralized transactions. * Cleared transactions. (a) * * * (3) Alternate requirements. Notwithstanding any other provision of this section, an advanced approaches Board-regulated institution or a Boardregulated institution that is not an advanced approaches Board-regulated institution and that has elected to use SA–CCR under § 217.34(a)(1) must apply § 217.133 to its derivative contracts that are cleared transactions rather than this section. * * * * (c) * * * (3) * * * (iii) For repo-style transactions and client-facing derivative transactions, a Board-regulated institution may multiply the standard supervisory haircuts provided in paragraphs (c)(3)(i) and (ii) of this section by the square root of 1⁄2 (which equals 0.707107). For client-facing derivative transactions, if a larger scaling factor is applied under § 217.34(f), the same factor must be used to adjust the supervisory haircuts. (iv) * * * (A) TM equals a holding period of longer than 10 business days for eligible margin loans and derivative contracts other than client-facing derivative transactions or longer than 5 business days for repo-style transactions and client-facing derivative transactions; * * * * * (C) TS equals 10 business days for eligible margin loans and derivative contracts other than client-facing derivative transactions or 5 business days for repo-style transactions and client-facing derivative transactions. * * * * * (4) * * * (i) * * * (B) The minimum holding period for a repo-style transaction and clientfacing derivative transaction is five business days and for an eligible margin loan and a derivative contract other than a client-facing derivative transaction is ten business days except for transactions or netting sets for which paragraph (c)(4)(i)(C) of this section applies. When a Board-regulated institution calculates an own-estimates haircut on a TN-day holding period, which is different from the minimum holding period for the transaction type, the applicable haircut (HM) is calculated using the following square root of time formula: * * * * * (1) TM equals 5 for repo-style transactions and client-facing derivative transactions and 10 for eligible margin loans and derivative contracts other than client-facing derivative transactions; * * * * * § § 217.134, 217.202, and 217.210 [Amended] 21. For each section listed in the following table, the footnote number listed in the ‘‘Old footnote number’’ column is redesignated as the footnote number listed in the ‘‘New footnote number’’ column as follows: ■ Old footnote number Section lotter on DSKBCFDHB2PROD with RULES2 217.134(d)(3) ........................................................................................................................................................... 217.202, paragraph (1) introductory text of the definition of ‘‘Covered position’’ ................................................... 217.202, paragraph (1)(i) of the definition of ‘‘Covered position’’ ........................................................................... 217.210(e)(1) ........................................................................................................................................................... 22. Section 217.132 is amended by: a. Revising paragraphs (b)(2)(ii)(A)(3) through (5); ■ b. Adding paragraphs (b)(2)(ii)(A)(6) and (7); ■ ■ VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 c. Revising paragraphs (c) heading and (c)(1) and (2) and (5) through (8); ■ d. Adding paragraphs (c)(9) through (11); ■ e. Revising paragraph (d)(10)(i); ■ PO 00000 Frm 00059 Fmt 4701 Sfmt 4702 New footnote number 30 31 32 33 31 32 33 34 f. In paragraphs (e)(5)(i)(A) and (H), removing ‘‘Table 3 to § 217.132’’ and adding in its place ‘‘Table 4 to this section’’; ■ E:\FR\FM\24JAR2.SGM 24JAR2 ER24JA20.024</GPH> exclude all of the contracts from any measure used to determine counterparty credit risk exposure. (f) Clearing member Board-regulated institution’s exposure amount. The exposure amount of a clearing member Board-regulated institution using CEM under paragraph (b) of this section for a client-facing derivative transaction or netting set of client-facing derivative transactions equals the exposure amount calculated according to paragraph (b)(1) or (2) of this section multiplied by the scaling factor the square root of 1⁄2 (which equals 0.707107). If the Board-regulated institution determines that a longer period is appropriate, the Boardregulated institution must use a larger scaling factor to adjust for a longer holding period as follows: Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations g. In paragraphs (e)(5)(i)(C) and (e)(6)(i)(B), removing ‘‘current exposure methodology’’ and adding in its place ‘‘standardized approach to counterparty credit risk’’ wherever it appears; ■ h. Redesignating Table 3 to § 217.132 following paragraph (e)(5)(ii) as Table 4 to § 217.132; and ■ i. Revising paragraph (e)(6)(viii). The revisions and additions read as follows: ■ § 217.132 Counterparty credit risk of repostyle transactions, eligible margin loans, and OTC derivative contracts. lotter on DSKBCFDHB2PROD with RULES2 * * * * * (b) * * * (2) * * * (ii) * * * (A) * * * (3) For repo-style transactions and client-facing derivative transactions, a Board-regulated institution may multiply the supervisory haircuts provided in paragraphs (b)(2)(ii)(A)(1) and (2) of this section by the square root of 1⁄2 (which equals 0.707107). If the Board-regulated institution determines that a longer holding period is appropriate for client-facing derivative transactions, then it must use a larger scaling factor to adjust for the longer holding period pursuant to paragraph (b)(2)(ii)(A)(6) of this section. (4) A Board-regulated institution must adjust the supervisory haircuts upward on the basis of a holding period longer than ten business days (for eligible margin loans) or five business days (for repo-style transactions), using the formula provided in paragraph (b)(2)(ii)(A)(6) of this section where the conditions in this paragraph (b)(2)(ii)(A)(4) apply. If the number of trades in a netting set exceeds 5,000 at any time during a quarter, a Boardregulated institution must adjust the supervisory haircuts upward on the basis of a minimum holding period of twenty business days for the following quarter (except when a Board-regulated institution is calculating EAD for a cleared transaction under § 217.133). If a netting set contains one or more trades involving illiquid collateral, a Boardregulated institution must adjust the supervisory haircuts upward on the basis of a minimum holding period of twenty business days. If over the two previous quarters more than two margin disputes on a netting set have occurred that lasted longer than the holding period, then the Board-regulated institution must adjust the supervisory haircuts upward for that netting set on the basis of a minimum holding period that is at least two times the minimum holding period for that netting set. (5)(i) A Board-regulated institution must adjust the supervisory haircuts VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 upward on the basis of a holding period longer than ten business days for collateral associated with derivative contracts (five business days for clientfacing derivative contracts) using the formula provided in paragraph (b)(2)(ii)(A)(6) of this section where the conditions in this paragraph (b)(2)(ii)(A)(5)(i) apply. For collateral associated with a derivative contract that is within a netting set that is composed of more than 5,000 derivative contracts that are not cleared transactions, a Board-regulated institution must use a minimum holding period of twenty business days. If a netting set contains one or more trades involving illiquid collateral or a derivative contract that cannot be easily replaced, a Board-regulated institution must use a minimum holding period of twenty business days. (ii) Notwithstanding paragraph (b)(2)(ii)(A)(1) or (3) or (b)(2)(ii)(A)(5)(i) of this section, for collateral associated with a derivative contract in a netting set under which more than two margin disputes that lasted longer than the holding period occurred during the two previous quarters, the minimum holding period is twice the amount provided under paragraph (b)(2)(ii)(A)(1) or (3) or (b)(2)(ii)(A)(5)(i) of this section. (6) A Board-regulated institution must adjust the standard supervisory haircuts upward, pursuant to the adjustments provided in paragraphs (b)(2)(ii)(A)(3) through (5) of this section, using the following formula: Where: TM equals a holding period of longer than 10 business days for eligible margin loans and derivative contracts other than client-facing derivative transactions or longer than 5 business days for repostyle transactions and client-facing derivative transactions; Hs equals the standard supervisory haircut; and Ts equals 10 business days for eligible margin loans and derivative contracts other than client-facing derivative transactions or 5 business days for repostyle transactions and client-facing derivative transactions. (7) If the instrument a Board-regulated institution has lent, sold subject to repurchase, or posted as collateral does not meet the definition of financial collateral, the Board-regulated PO 00000 Frm 00060 Fmt 4701 Sfmt 4702 institution must use a 25.0 percent haircut for market price volatility (Hs). * * * * * (c) EAD for derivative contracts—(1) Options for determining EAD. A Boardregulated institution must determine the EAD for a derivative contract using the standardized approach for counterparty credit risk (SA–CCR) under paragraph (c)(5) of this section or using the internal models methodology described in paragraph (d) of this section. If a Board-regulated institution elects to use SA–CCR for one or more derivative contracts, the exposure amount determined under SA–CCR is the EAD for the derivative contract or derivatives contracts. A Board-regulation institution must use the same methodology to calculate the exposure amount for all its derivative contracts and may change its election only with prior approval of the Board. A Board-regulated institution may reduce the EAD calculated according to paragraph (c)(5) of this section by the credit valuation adjustment that the Board-regulated institution has recognized in its balance sheet valuation of any derivative contracts in the netting set. For purposes of this paragraph (c)(1), the credit valuation adjustment does not include any adjustments to common equity tier 1 capital attributable to changes in the fair value of the Boardregulated institution’s liabilities that are due to changes in its own credit risk since the inception of the transaction with the counterparty. (2) Definitions. For purposes of this paragraph (c) of this section, the following definitions apply: (i) End date means the last date of the period referenced by an interest rate or credit derivative contract or, if the derivative contract references another instrument, by the underlying instrument, except as otherwise provided in paragraph (c) of this section. (ii) Start date means the first date of the period referenced by an interest rate or credit derivative contract or, if the derivative contract references the value of another instrument, by underlying instrument, except as otherwise provided in paragraph (c) of this section. (iii) Hedging set means: (A) With respect to interest rate derivative contracts, all such contracts within a netting set that reference the same reference currency; (B) With respect to exchange rate derivative contracts, all such contracts within a netting set that reference the same currency pair; E:\FR\FM\24JAR2.SGM 24JAR2 ER24JA20.025</GPH> 4420 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations this section, the exposure amount of a netting set that consists of only sold options in which the premiums have been fully paid by the counterparty to the options and where the options are not subject to a variation margin agreement is zero. (iv) Notwithstanding the requirements of paragraph (c)(5)(i) of this section, the exposure amount of a netting set in which the counterparty is a commercial end-user is equal to the sum of replacement cost, as calculated under paragraph (c)(6) of this section, and the potential future exposure of the netting set, as calculated under paragraph (c)(7) of this section. (v) For purposes of the exposure amount calculated under paragraph (c)(5)(i) of this section and all calculations that are part of that exposure amount, a Board-regulated institution may elect to treat a derivative contract that is a cleared transaction that is not subject to a variation margin agreement as one that is subject to a variation margin agreement, if the derivative contract is subject to a requirement that the counterparties make daily cash payments to each other to account for changes in the fair value of the derivative contract and to reduce the net position of the contract to zero. If a Board-regulated institution makes an election under this paragraph (c)(5)(v) for one derivative contract, it must treat all other derivative contracts within the same netting set that are eligible for an election under this paragraph (c)(5)(v) as derivative contracts that are subject to a variation margin agreement. (vi) For purposes of the exposure amount calculated under paragraph (c)(5)(i) of this section and all calculations that are part of that exposure amount, a Board-regulated institution may elect to treat a credit derivative contract, equity derivative contract, or commodity derivative contract that references an index as if it were multiple derivative contracts each referencing one component of the index. (6) Replacement cost of a netting set— (i) Netting set subject to a variation margin agreement under which the counterparty must post variation margin. The replacement cost of a netting set subject to a variation margin agreement, excluding a netting set that is subject to a variation margin PFE multiplier= min { 1; 0.05 VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 PO 00000 Frm 00061 Fmt 4701 Sfmt 4702 agreement under which the counterparty is not required to post variation margin, is the greater of: (A) The sum of the fair values (after excluding any valuation adjustments) of the derivative contracts within the netting set less the sum of the net independent collateral amount and the variation margin amount applicable to such derivative contracts; (B) The sum of the variation margin threshold and the minimum transfer amount applicable to the derivative contracts within the netting set less the net independent collateral amount applicable to such derivative contracts; or (C) Zero. (ii) Netting sets not subject to a variation margin agreement under which the counterparty must post variation margin. The replacement cost of a netting set that is not subject to a variation margin agreement under which the counterparty must post variation margin to the Board-regulated institution is the greater of: (A) The sum of the fair values (after excluding any valuation adjustments) of the derivative contracts within the netting set less the sum of the net independent collateral amount and variation margin amount applicable to such derivative contracts; or (B) Zero. (iii) Multiple netting sets subject to a single variation margin agreement. Notwithstanding paragraphs (c)(6)(i) and (ii) of this section, the replacement cost for multiple netting sets subject to a single variation margin agreement must be calculated according to paragraph (c)(10)(i) of this section. (iv) Netting set subject to multiple variation margin agreements or a hybrid netting set. Notwithstanding paragraphs (c)(6)(i) and (ii) of this section, the replacement cost for a netting set subject to multiple variation margin agreements or a hybrid netting set must be calculated according to paragraph (c)(11)(i) of this section. (7) Potential future exposure of a netting set. The potential future exposure of a netting set is the product of the PFE multiplier and the aggregated amount. (i) PFE multiplier. The PFE multiplier is calculated according to the following formula: + 0.95 * e(;;.~)} E:\FR\FM\24JAR2.SGM 24JAR2 ER24JA20.026</GPH> lotter on DSKBCFDHB2PROD with RULES2 (C) With respect to credit derivative contract, all such contracts within a netting set; (D) With respect to equity derivative contracts, all such contracts within a netting set; (E) With respect to a commodity derivative contract, all such contracts within a netting set that reference one of the following commodity categories: Energy, metal, agricultural, or other commodities; (F) With respect to basis derivative contracts, all such contracts within a netting set that reference the same pair of risk factors and are denominated in the same currency; or (G) With respect to volatility derivative contracts, all such contracts within a netting set that reference one of interest rate, exchange rate, credit, equity, or commodity risk factors, separated according to the requirements under paragraphs (c)(2)(iii)(A) through (E) of this section. (H) If the risk of a derivative contract materially depends on more than one of interest rate, exchange rate, credit, equity, or commodity risk factors, the Board may require a Board-regulated institution to include the derivative contract in each appropriate hedging set under paragraphs (c)(1)(iii)(A) through (E) of this section. * * * * * (5) Exposure amount. (i) The exposure amount of a netting set, as calculated under paragraph (c) of this section, is equal to 1.4 multiplied by the sum of the replacement cost of the netting set, as calculated under paragraph (c)(6) of this section, and the potential future exposure of the netting set, as calculated under paragraph (c)(7) of this section. (ii) Notwithstanding the requirements of paragraph (c)(5)(i) of this section, the exposure amount of a netting set subject to a variation margin agreement, excluding a netting set that is subject to a variation margin agreement under which the counterparty to the variation margin agreement is not required to post variation margin, is equal to the lesser of the exposure amount of the netting set calculated under paragraph (c)(5)(i) of this section and the exposure amount of the netting set calculated under paragraph (c)(5)(i) of this section as if the netting set were not subject to a variation margin agreement. (iii) Notwithstanding the requirements of paragraph (c)(5)(i) of 4421 4422 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations Where: V is the sum of the fair values (after excluding any valuation adjustments) of the derivative contracts within the netting set; C is the sum of the net independent collateral amount and the variation margin amount applicable to the derivative contracts within the netting set; and A is the aggregated amount of the netting set. (ii) Aggregated amount. The aggregated amount is the sum of all hedging set amounts, as calculated under paragraph (c)(8) of this section, within a netting set. (iii) Multiple netting sets subject to a single variation margin agreement. Notwithstanding paragraphs (c)(7)(i) and (ii) of this section and when calculating the potential future exposure for purposes of total leverage exposure under § 217.10(c)(4)(ii)(B)(2), the potential future exposure for multiple netting sets subject to a single variation margin agreement must be calculated according to paragraph (c)(10)(ii) of this section. (iv) Netting set subject to multiple variation margin agreements or a hybrid netting set. Notwithstanding paragraphs (c)(7)(i) and (ii) of this section and when calculating the potential future exposure for purposes of total leverage exposure Hedging set amount = [(AddOn~i 1 )2 under § 217.10(c)(4)(ii)(B)(2), the potential future exposure for a netting set subject to multiple variation margin agreements or a hybrid netting set must be calculated according to paragraph (c)(11)(ii) of this section. (8) Hedging set amount—(i) Interest rate derivative contracts. To calculate the hedging set amount of an interest rate derivative contract hedging set, a Board-regulated institution may use either of the formulas provided in paragraphs (c)(8)(i)(A) and (B) of this section: (A) Formula 1 is as follows: + (AddOn~i 2 ) 2 + 1 Add0n~i 3 + 0.6 * AddOn~i 1 * Add0n~i 3 )]2; or (B) Formula 2 is as follows: Hedging set amount = |AddOnIRTB1| + |AddOnIRTB2| + |AddOnIRTB3|. Where in paragraphs (c)(8)(i)(A) and (B) of this section: AddOnIRTB1 is the sum of the adjusted derivative contract amounts, as calculated under paragraph (c)(9) of this section, within the hedging set with an end date of less than one year from the present date; AddOnIRTB2 is the sum of the adjusted derivative contract amounts, as calculated under paragraph (c)(9) of this section, within the hedging set with an end date of one to five years from the present date; and AddOnIRTB3 is the sum of the adjusted derivative contract amounts, as calculated under paragraph (c)(9) of this section, within the hedging set with an end date of more than five years from the present date. (ii) Exchange rate derivative contracts. For an exchange rate derivative contract hedging set, the hedging set amount equals the absolute value of the sum of the adjusted derivative contract amounts, as calculated under paragraph (c)(9) of this section, within the hedging set. (iii) Credit derivative contracts and equity derivative contracts. The hedging set amount of a credit derivative contract hedging set or equity derivative contract hedging set within a netting set is calculated according to the following formula: 1 (Add0n(Refk)) 2 F (iv) Commodity derivative contracts. The hedging set amount of a commodity derivative contract hedging set within a netting set is calculated according to the following formula: ER24JA20.028</GPH> determined under paragraph (c)(9) of this section, for all derivative contracts within the hedging set that reference reference entity k. rk equals the applicable supervisory correlation factor, as provided in Table 2 to this section. VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 PO 00000 Frm 00062 Fmt 4701 Sfmt 4702 E:\FR\FM\24JAR2.SGM 24JAR2 ER24JA20.027</GPH> lotter on DSKBCFDHB2PROD with RULES2 Where: k is each reference entity within the hedging set. K is the number of reference entities within the hedging set. AddOn(Refk) equals the sum of the adjusted derivative contract amounts, as Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4423 Hedging set amount 1 (v) Basis derivative contracts and volatility derivative contracts. Notwithstanding paragraphs (c)(8)(i) through (iv) of this section, a Boardregulated institution must calculate a separate hedging set amount for each basis derivative contract hedging set and each volatility derivative contract hedging set. A Board-regulated institution must calculate such hedging set amounts using one of the formulas under paragraphs (c)(8)(i) through (iv) that corresponds to the primary risk factor of the hedging set being calculated. (9) Adjusted derivative contract amount—(i) Summary. To calculate the adjusted derivative contract amount of a derivative contract, a Board-regulated institution must determine the adjusted notional amount of derivative contract, pursuant to paragraph (c)(9)(ii) of this section, and multiply the adjusted Supervisory duration lotter on DSKBCFDHB2PROD with RULES2 Where: S is the number of business days from the present day until the start date of the derivative contract, or zero if the start date has already passed; and E is the number of business days from the present day until the end date of the derivative contract. (2) For purposes of paragraph (c)(9)(ii)(A)(1) of this section: (i) For an interest rate derivative contract or credit derivative contract that is a variable notional swap, the notional amount is equal to the timeweighted average of the contractual notional amounts of such a swap over the remaining life of the swap; and (ii) For an interest rate derivative contract or a credit derivative contract that is a leveraged swap, in which the notional amount of all legs of the derivative contract are divided by a factor and all rates of the derivative contract are multiplied by the same factor, the notional amount is equal to the notional amount of an equivalent unleveraged swap. (B)(1) For an exchange rate derivative contract, the adjusted notional amount is the notional amount of the non-U.S. VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 = max { e -o.os• ( 2~ 0 ) _ -o.os• (/50 )) e 0.05 denominated currency leg of the derivative contract, as measured in U.S. dollars using the exchange rate on the date of the calculation. If both legs of the exchange rate derivative contract are denominated in currencies other than U.S. dollars, the adjusted notional amount of the derivative contract is the largest leg of the derivative contract, as measured in U.S. dollars using the exchange rate on the date of the calculation. (2) Notwithstanding paragraph (c)(9)(ii)(B)(1) of this section, for an exchange rate derivative contract with multiple exchanges of principal, the Board-regulated institution must set the adjusted notional amount of the derivative contract equal to the notional amount of the derivative contract multiplied by the number of exchanges of principal under the derivative contract. (C)(1) For an equity derivative contract or a commodity derivative contract, the adjusted notional amount is the product of the fair value of one unit of the reference instrument underlying the derivative contract and PO 00000 Frm 00063 Fmt 4701 notional amount by each of the supervisory delta adjustment, pursuant to paragraph (c)(9)(iii) of this section, the maturity factor, pursuant to paragraph (c)(9)(iv) of this section, and the applicable supervisory factor, as provided in Table 2 to this section. (ii) Adjusted notional amount. (A)(1) For an interest rate derivative contract or a credit derivative contract, the adjusted notional amount equals the product of the notional amount of the derivative contract, as measured in U.S. dollars using the exchange rate on the date of the calculation, and the supervisory duration, as calculated by the following formula: Sfmt 4702 , 0.04 } the number of such units referenced by the derivative contract. (2) Notwithstanding paragraph (c)(9)(ii)(C)(1) of this section, when calculating the adjusted notional amount for an equity derivative contract or a commodity derivative contract that is a volatility derivative contract, the Board-regulated institution must replace the unit price with the underlying volatility referenced by the volatility derivative contract and replace the number of units with the notional amount of the volatility derivative contract. (iii) Supervisory delta adjustments. (A) For a derivative contract that is not an option contract or collateralized debt obligation tranche, the supervisory delta adjustment is 1 if the fair value of the derivative contract increases when the value of the primary risk factor increases and ¥1 if the fair value of the derivative contract decreases when the value of the primary risk factor increases. (B)(1) For a derivative contract that is an option contract, the supervisory delta adjustment is determined by the following formulas, as applicable: E:\FR\FM\24JAR2.SGM 24JAR2 ER24JA20.030</GPH> Where: k is each commodity type within the hedging set. K is the number of commodity types within the hedging set. AddOn(Typek) equals the sum of the adjusted derivative contract amounts, as determined under paragraph (c)(9) of this section, for all derivative contracts within the hedging set that reference reference commodity type. r equals the applicable supervisory correlation factor, as provided in Table 2 to this section. zl2 ER24JA20.029</GPH> ~K * Lk=l (AddOn(Typek)) 4424 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations Table 2 to §217.132--Supervisory Delta Adjustment for Options Contracts Sokl Bou&bt )+0.S• r a • Put Optiom ➔(-1n(~ /f /250 • T /250) ➔(1n(: !~ )+0.5• r • T /250) o • .JT /250 H )+o.s. r. T /250) •( 1n(I; a • .JT /250 (2) As used in the formulas in Table 2 to this section: (i) F is the standard normal cumulative distribution function; (ii) P equals the current fair value of the instrument or risk factor, as applicable, underlying the option; (iii) K equals the strike price of the option; (iv) T equals the number of business days until the latest contractual exercise date of the option; a • .JT /250 (v) l equals zero for all derivative contracts except interest rate options for the currencies where interest rates have negative values. The same value of l must be used for all interest rate options that are denominated in the same currency. To determine the value of l for a given currency, a Board-regulated institution must find the lowest value L of P and K of all interest rate options in a given currency that the Board- Supervisory delta adjustment lotter on DSKBCFDHB2PROD with RULES2 (2) As used in the formula in paragraph (c)(9)(iii)(C)(1) of this section: (i) A is the attachment point, which equals the ratio of the notional amounts of all underlying exposures that are subordinated to the Board-regulated institution’s exposure to the total notional amount of all underlying exposures, expressed as a decimal value between zero and one; 30 (ii) D is the detachment point, which equals one minus the ratio of the notional amounts of all underlying exposures that are senior to the Boardregulated institution’s exposure to the total notional amount of all underlying exposures, expressed as a decimal value between zero and one; and (iii) The resulting amount is designated with a positive sign if the collateralized debt obligation tranche was purchased by the Board-regulated institution and is designated with a 30 In the case of a first-to-default credit derivative, there are no underlying exposures that are subordinated to the Board-regulated institution’s exposure. In the case of a second-or-subsequent-todefault credit derivative, the smallest (n¥1) notional amounts of the underlying exposures are subordinated to the Board-regulated institution’s exposure. VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 . Maturity factor = 23 ✓MPOR 250 Where MPOR refers to the period from the most recent exchange of collateral covering a netting set of derivative contracts with a defaulting counterparty until the derivative contracts are closed out and the resulting market risk is re-hedged. (2) Notwithstanding paragraph (c)(9)(iv)(A)(1) of this section: (i) For a derivative contract that is not a client-facing derivative transaction, MPOR cannot be less than ten business days plus the periodicity of re- Frm 00064 Fmt 4701 regulated institution has with all counterparties. Then, l is set according to this formula: l = max{¥L + 0.1%, 0}; and (vi) s equals the supervisory option volatility, as provided in Table 3 to this section. (C)(1) For a derivative contract that is a collateralized debt obligation tranche, the supervisory delta adjustment is determined by the following formula: = C1+14*A)1*: 1+14*D) negative sign if the collateralized debt obligation tranche was sold by the Board-regulated institution. (iv) Maturity factor. (A)(1) The maturity factor of a derivative contract that is subject to a variation margin agreement, excluding derivative contracts that are subject to a variation margin agreement under which the counterparty is not required to post variation margin, is determined by the following formula: PO 00000 H) +o.s• r. T /250) Sfmt 4702 margining expressed in business days minus one business day; (ii) For a derivative contract that is a client-facing derivative transaction, cannot be less than five business days plus the periodicity of re-margining expressed in business days minus one business day; and (iii) For a derivative contract that is within a netting set that is composed of more than 5,000 derivative contracts that are not cleared transactions, or a netting set that contains one or more trades involving illiquid collateral or a derivative contract that cannot be easily replaced, MPOR cannot be less than twenty business days. (3) Notwithstanding paragraphs (c)(9)(iv)(A)(1) and (2) of this section, for a netting set subject to two or more outstanding disputes over margin that lasted longer than the MPOR over the previous two quarters, the applicable floor is twice the amount provided in (c)(9)(iv)(A)(1) and (2) of this section. (B) The maturity factor of a derivative contract that is not subject to a variation margin agreement, or derivative contracts under which the counterparty E:\FR\FM\24JAR2.SGM 24JAR2 ER24JA20.032</GPH> ER24JA20.033</GPH> ·(In~ !~ ER24JA20.031</GPH> Call Optiom Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations Maturity factor = min{M;zso} lotter on DSKBCFDHB2PROD with RULES2 250 Where M equals the greater of 10 business days and the remaining maturity of the contract, as measured in business days. (C) For purposes of paragraph (c)(9)(iv) of this section, if a Boardregulated institution has elected pursuant to paragraph (c)(5)(v) of this section to treat a derivative contract that is a cleared transaction that is not subject to a variation margin agreement as one that is subject to a variation margin agreement, the Board-regulated institution must treat the derivative contract as subject to a variation margin agreement with maturity factor as determined according to (c)(9)(iv)(A) of this section, and daily settlement does not change the end date of the period referenced by the derivative contract. (v) Derivative contract as multiple effective derivative contracts. A Boardregulated institution must separate a derivative contract into separate derivative contracts, according to the following rules: (A) For an option where the counterparty pays a predetermined amount if the value of the underlying asset is above or below the strike price and nothing otherwise (binary option), the option must be treated as two separate options. For purposes of paragraph (c)(9)(iii)(B) of this section, a binary option with strike K must be represented as the combination of one bought European option and one sold European option of the same type as the original option (put or call) with the strikes set equal to 0.95 * K and 1.05 * K so that the payoff of the binary option is reproduced exactly outside the region between the two strikes. The absolute value of the sum of the adjusted derivative contract amounts of the bought and sold options is capped at the payoff amount of the binary option. (B) For a derivative contract that can be represented as a combination of standard option payoffs (such as collar, butterfly spread, calendar spread, straddle, and strangle), a Boardregulated institution must treat each standard option component as a separate derivative contract. (C) For a derivative contract that includes multiple-payment options, (such as interest rate caps and floors), a VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 Board-regulated institution may represent each payment option as a combination of effective single-payment options (such as interest rate caplets and floorlets). (D) A Board-regulated institution may not decompose linear derivative contracts (such as swaps) into components. (10) Multiple netting sets subject to a single variation margin agreement—(i) Calculating replacement cost. Notwithstanding paragraph (c)(6) of this section, a Board-regulated institution shall assign a single replacement cost to multiple netting sets that are subject to a single variation margin agreement under which the counterparty must post variation margin, calculated according to the following formula: Replacement Cost = max{SNSmax{VNS; 0} ¥ max{CMA; 0}; 0} + max{SNSmin{VNS; 0} ¥ min{CMA; 0}; 0} Where: NS is each netting set subject to the variation margin agreement MA; VNS is the sum of the fair values (after excluding any valuation adjustments) of the derivative contracts within the netting set NS; and CMA is the sum of the net independent collateral amount and the variation margin amount applicable to the derivative contracts within the netting sets subject to the single variation margin agreement. (ii) Calculating potential future exposure. Notwithstanding paragraph (c)(5) of this section, a Board-regulated institution shall assign a single potential future exposure to multiple netting sets that are subject to a single variation margin agreement under which the counterparty must post variation margin equal to the sum of the potential future exposure of each such netting set, each calculated according to paragraph (c)(7) of this section as if such nettings sets were not subject to a variation margin agreement. (11) Netting set subject to multiple variation margin agreements or a hybrid netting set—(i) Calculating replacement cost. To calculate replacement cost for either a netting set subject to multiple variation margin agreements under which the counterparty to each variation margin agreement must post variation margin, or a netting set composed of at least one derivative contract subject to variation margin agreement under which the counterparty must post variation margin PO 00000 Frm 00065 Fmt 4701 Sfmt 4702 and at least one derivative contract that is not subject to such a variation margin agreement, the calculation for replacement cost is provided under paragraph (c)(6)(i) of this section, except that the variation margin threshold equals the sum of the variation margin thresholds of all variation margin agreements within the netting set and the minimum transfer amount equals the sum of the minimum transfer amounts of all the variation margin agreements within the netting set. (ii) Calculating potential future exposure. (A) To calculate potential future exposure for a netting set subject to multiple variation margin agreements under which the counterparty to each variation margin agreement must post variation margin, or a netting set composed of at least one derivative contract subject to variation margin agreement under which the counterparty to the derivative contract must post variation margin and at least one derivative contract that is not subject to such a variation margin agreement, a Board-regulated institution must divide the netting set into subnetting sets (as described in paragraph (c)(11)(ii)(B) of this section) and calculate the aggregated amount for each sub-netting set. The aggregated amount for the netting set is calculated as the sum of the aggregated amounts for the sub-netting sets. The multiplier is calculated for the entire netting set. (B) For purposes of paragraph (c)(11)(ii)(A) of this section, the netting set must be divided into sub-netting sets as follows: (1) All derivative contracts within the netting set that are not subject to a variation margin agreement or that are subject to a variation margin agreement under which the counterparty is not required to post variation margin form a single sub-netting set. The aggregated amount for this sub-netting set is calculated as if the netting set is not subject to a variation margin agreement. (2) All derivative contracts within the netting set that are subject to variation margin agreements in which the counterparty must post variation margin and that share the same value of the MPOR form a single sub-netting set. The aggregated amount for this sub-netting set is calculated as if the netting set is subject to a variation margin agreement, using the MPOR value shared by the derivative contracts within the netting set. E:\FR\FM\24JAR2.SGM 24JAR2 ER24JA20.034</GPH> is not required to post variation margin, is determined by the following formula: 4425 4426 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations TABLE 3 TO § 217.132—SUPERVISORY OPTION VOLATILITY, SUPERVISORY CORRELATION PARAMETERS, AND SUPERVISORY FACTORS FOR DERIVATIVE CONTRACTS Supervisory option volatility (percent) Asset class Category Type Interest rate ........................... Exchange rate ....................... Credit, single name ............... N/A ........................................ N/A ........................................ Investment grade .................. Speculative grade ................. Sub-speculative grade .......... Investment Grade ................. Speculative Grade ................ N/A ........................................ N/A ........................................ Energy ................................... N/A ........................................ N/A ........................................ N/A ........................................ N/A ........................................ N/A ........................................ N/A ........................................ N/A ........................................ N/A ........................................ N/A ........................................ Electricity ............................... Other ..................................... N/A ........................................ N/A ........................................ N/A ........................................ Credit, index .......................... Equity, single name .............. Equity, index ......................... Commodity ............................ Metals ................................... Agricultural ............................ Other ..................................... 50 15 100 100 100 80 80 120 75 150 70 70 70 70 Supervisory correlation factor (percent) N/A N/A 50 50 50 80 80 50 80 40 40 40 40 40 Supervisory factor 1 (percent) 0.50 4.0 0.46 1.3 6.0 0.38 1.06 32 20 40 18 18 18 18 lotter on DSKBCFDHB2PROD with RULES2 1 The applicable supervisory factor for basis derivative contract hedging sets is equal to one-half of the supervisory factor provided in this Table 3, and the applicable supervisory factor for volatility derivative contract hedging sets is equal to 5 times the supervisory factor provided in this Table 3. (d) * * * (10) * * * (i) With prior written approval of the Board, a Board-regulated institution may set EAD equal to a measure of counterparty credit risk exposure, such as peak EAD, that is more conservative than an alpha of 1.4 times the larger of EPEunstressed and EPEstressed for every counterparty whose EAD will be measured under the alternative measure of counterparty exposure. The Boardregulated institution must demonstrate the conservatism of the measure of counterparty credit risk exposure used for EAD. With respect to paragraph (d)(10)(i) of this section: (A) For material portfolios of new OTC derivative products, the Boardregulated institution may assume that the standardized approach for counterparty credit risk pursuant to paragraph (c) of this section meets the conservatism requirement of this section for a period not to exceed 180 days. (B) For immaterial portfolios of OTC derivative contracts, the Board-regulated institution generally may assume that the standardized approach for counterparty credit risk pursuant to paragraph (c) of this section meets the conservatism requirement of this section. * * * * * (e) * * * (6) * * * (viii) If a Board-regulated institution uses the standardized approach for counterparty credit risk pursuant to paragraph (c) of this section to calculate the EAD for any immaterial portfolios of OTC derivative contracts, the Boardregulated institution must use that EAD as a constant EE in the formula for the VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 calculation of CVA with the maturity equal to the maximum of: (A) Half of the longest maturity of a transaction in the netting set; and (B) The notional weighted average maturity of all transactions in the netting set. ■ 23. Section 217.133 is amended by revising paragraphs (a), (b)(1) through (3), (b)(4)(i), (c)(1) through (3), (c)(4)(i), and (d) to read as follows: § 217.133 Cleared transactions. (a) General requirements—(1) Clearing member clients. A Boardregulated institution that is a clearing member client must use the methodologies described in paragraph (b) of this section to calculate riskweighted assets for a cleared transaction. (2) Clearing members. A Boardregulated institution that is a clearing member must use the methodologies described in paragraph (c) of this section to calculate its risk-weighted assets for a cleared transaction and paragraph (d) of this section to calculate its risk-weighted assets for its default fund contribution to a CCP. (b) * * * (1) Risk-weighted assets for cleared transactions. (i) To determine the riskweighted asset amount for a cleared transaction, a Board-regulated institution that is a clearing member client must multiply the trade exposure amount for the cleared transaction, calculated in accordance with paragraph (b)(2) of this section, by the risk weight appropriate for the cleared transaction, determined in accordance with paragraph (b)(3) of this section. PO 00000 Frm 00066 Fmt 4701 Sfmt 4702 (ii) A clearing member client Boardregulated institution’s total riskweighted assets for cleared transactions is the sum of the risk-weighted asset amounts for all of its cleared transactions. (2) Trade exposure amount. (i) For a cleared transaction that is a derivative contract or a netting set of derivative contracts, trade exposure amount equals the EAD for the derivative contract or netting set of derivative contracts calculated using the methodology used to calculate EAD for derivative contracts set forth in § 217.132(c) or (d), plus the fair value of the collateral posted by the clearing member client Board-regulated institution and held by the CCP or a clearing member in a manner that is not bankruptcy remote. When the Boardregulated institution calculates EAD for the cleared transaction using the methodology in § 217.132(d), EAD equals EADunstressed. (ii) For a cleared transaction that is a repo-style transaction or netting set of repo-style transactions, trade exposure amount equals the EAD for the repostyle transaction calculated using the methodology set forth in § 217.132(b)(2) or (3) or (d), plus the fair value of the collateral posted by the clearing member client Board-regulated institution and held by the CCP or a clearing member in a manner that is not bankruptcy remote. When the Board-regulated institution calculates EAD for the cleared transaction under § 217.132(d), EAD equals EADunstressed. (3) Cleared transaction risk weights. (i) For a cleared transaction with a QCCP, a clearing member client Boardregulated institution must apply a risk weight of: E:\FR\FM\24JAR2.SGM 24JAR2 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations KcM VerDate Sep<11>2014 17:27 Jan 23, 2020 (ii) A clearing member Boardregulated institution’s total riskweighted assets for cleared transactions is the sum of the risk-weighted asset amounts for all of its cleared transactions. (2) Trade exposure amount. A clearing member Board-regulated institution must calculate its trade exposure amount for a cleared transaction as follows: (i) For a cleared transaction that is a derivative contract or a netting set of derivative contracts, trade exposure amount equals the EAD calculated using the methodology used to calculate EAD for derivative contracts set forth in § 217.132(c) or (d), plus the fair value of the collateral posted by the clearing member Board-regulated institution and held by the CCP in a manner that is not bankruptcy remote. When the clearing member Board-regulated institution calculates EAD for the cleared transaction using the methodology in § 217.132(d), EAD equals EADunstressed. (ii) For a cleared transaction that is a repo-style transaction or netting set of repo-style transactions, trade exposure amount equals the EAD calculated under § 217.132(b)(2) or (3) or (d), plus the fair value of the collateral posted by the clearing member Board-regulated institution and held by the CCP in a manner that is not bankruptcy remote. When the clearing member Boardregulated institution calculates EAD for the cleared transaction under § 217.132(d), EAD equals EADunstressed. (3) Cleared transaction risk weights. (i) A clearing member Board-regulated institution must apply a risk weight of 2 percent to the trade exposure amount for a cleared transaction with a QCCP. (ii) For a cleared transaction with a CCP that is not a QCCP, a clearing member Board-regulated institution must apply the risk weight applicable to the CCP according to subpart D of this part. (iii) Notwithstanding paragraphs (c)(3)(i) and (ii) of this section, a clearing member Board-regulated institution may apply a risk weight of zero percent to the trade exposure amount for a cleared transaction with a QCCP where the clearing member Board-regulated institution is acting as a financial intermediary on behalf of a clearing member client, the transaction = max{KccP * ( Jkt 250001 PO 00000 DFpref pref ) ; D F CCP + D FCCPCM Frm 00067 Fmt 4701 Sfmt 4702 offsets another transaction that satisfies the requirements set forth in § 217.3(a), and the clearing member Boardregulated institution is not obligated to reimburse the clearing member client in the event of the QCCP default. (4) * * * (i) Notwithstanding any other requirement of this section, collateral posted by a clearing member Boardregulated institution that is held by a custodian (in its capacity as a custodian) in a manner that is bankruptcy remote from the CCP, clearing member, and other clearing member clients of the clearing member, is not subject to a capital requirement under this section. * * * * * (d) Default fund contributions—(1) General requirement. A clearing member Board-regulated institution must determine the risk-weighted asset amount for a default fund contribution to a CCP at least quarterly, or more frequently if, in the opinion of the Board-regulated institution or the Board, there is a material change in the financial condition of the CCP. (2) Risk-weighted asset amount for default fund contributions to nonqualifying CCPs. A clearing member Board-regulated institution’s riskweighted asset amount for default fund contributions to CCPs that are not QCCPs equals the sum of such default fund contributions multiplied by 1,250 percent, or an amount determined by the Board, based on factors such as size, structure, and membership characteristics of the CCP and riskiness of its transactions, in cases where such default fund contributions may be unlimited. (3) Risk-weighted asset amount for default fund contributions to QCCPs. A clearing member Board-regulated institution’s risk-weighted asset amount for default fund contributions to QCCPs equals the sum of its capital requirement, KCM for each QCCP, as calculated under the methodology set forth in paragraph (d)(4) of this section, multiplied by 12.5. (4) Capital requirement for default fund contributions to a QCCP. A clearing member Board-regulated institution’s capital requirement for its default fund contribution to a QCCP (KCM) is equal to: 0.16 percent* DFpref} E:\FR\FM\24JAR2.SGM 24JAR2 ER24JA20.035</GPH> lotter on DSKBCFDHB2PROD with RULES2 (A) 2 percent if the collateral posted by the Board-regulated institution to the QCCP or clearing member is subject to an arrangement that prevents any loss to the clearing member client Boardregulated institution due to the joint default or a concurrent insolvency, liquidation, or receivership proceeding of the clearing member and any other clearing member clients of the clearing member; and the clearing member client Board-regulated institution has conducted sufficient legal review to conclude with a well-founded basis (and maintains sufficient written documentation of that legal review) that in the event of a legal challenge (including one resulting from an event of default or from liquidation, insolvency, or receivership proceedings) the relevant court and administrative authorities would find the arrangements to be legal, valid, binding, and enforceable under the law of the relevant jurisdictions. (B) 4 percent, if the requirements of paragraph (b)(3)(i)(A) of this section are not met. (ii) For a cleared transaction with a CCP that is not a QCCP, a clearing member client Board-regulated institution must apply the risk weight applicable to the CCP under subpart D of this part. (4) * * * (i) Notwithstanding any other requirement of this section, collateral posted by a clearing member client Board-regulated institution that is held by a custodian (in its capacity as a custodian) in a manner that is bankruptcy remote from the CCP, clearing member, and other clearing member clients of the clearing member, is not subject to a capital requirement under this section. * * * * * (c) * * * (1) Risk-weighted assets for cleared transactions. (i) To determine the riskweighted asset amount for a cleared transaction, a clearing member Boardregulated institution must multiply the trade exposure amount for the cleared transaction, calculated in accordance with paragraph (c)(2) of this section by the risk weight appropriate for the cleared transaction, determined in accordance with paragraph (c)(3) of this section. 4427 4428 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations Where: KCCP is the hypothetical capital requirement of the QCCP, as determined under paragraph (d)(5) of this section; DFpref is the prefunded default fund contribution of the clearing member Board-regulated institution to the QCCP; DFCCP is the QCCP’s own prefunded amounts that are contributed to the default waterfall and are junior or pari passu with prefunded default fund contributions of clearing members of the CCP; and DFCMpref is the total prefunded default fund contributions from clearing members of the QCCP to the QCCP. (5) Hypothetical capital requirement of a QCCP. Where a QCCP has provided its KCCP, a Board-regulated institution must rely on such disclosed figure instead of calculating KCCP under this paragraph (d)(5), unless the Boardregulated institution determines that a more conservative figure is appropriate based on the nature, structure, or characteristics of the QCCP. The hypothetical capital requirement of a QCCP (KCCP), as determined by the Board-regulated institution, is equal to: KCCP = SCMi EADi * 1.6 percent Where: CMi is each clearing member of the QCCP; and EADi is the exposure amount of each clearing member of the QCCP to the QCCP, as determined under paragraph (d)(6) of this section. (6) EAD of a clearing member Boardregulated institution to a QCCP. (i) The EAD of a clearing member Boardregulated institution to a QCCP is equal to the sum of the EAD for derivative contracts determined under paragraph (d)(6)(ii) of this section and the EAD for repo-style transactions determined under paragraph (d)(6)(iii) of this section. (ii) With respect to any derivative contracts between the Board-regulated institution and the CCP that are cleared transactions and any guarantees that the Board-regulated institution has provided to the CCP with respect to performance of a clearing member client on a derivative contract, the EAD is equal to the exposure amount for all such derivative contracts and guarantees of derivative contracts calculated under SA–CCR in § 217.132(c) (or, with respect to a CCP located outside the United States, under a substantially identical methodology in effect in the jurisdiction) using a value of 10 business days for purposes of § 217.132(c)(9)(iv); less the value of all collateral held by the CCP posted by the clearing member Board-regulated institution or a clearing member client of the Board-regulated institution in connection with a derivative contract for which the Board-regulated institution has provided a guarantee to the CCP and the amount of the prefunded default fund contribution of the Board-regulated institution to the CCP. (iii) With respect to any repo-style transactions between the Boardregulated institution and the CCP that are cleared transactions, EAD is equal to: EAD = max{EBRM¥IM¥DF; 0} Where: EBRM is the sum of the exposure amounts of each repo-style transaction between the Board-regulated institution and the CCP as determined under § 217.132(b)(2) and without recognition of any collateral securing the repo-style transactions; IM is the initial margin collateral posted by the Board-regulated institution to the CCP with respect to the repo-style transactions; and DF is the prefunded default fund contribution of the Board-regulated institution to the CCP that is not already deducted in § 217.133(d)(6)(ii). (iv) EAD must be calculated separately for each clearing member’s sub-client accounts and sub-house account (i.e., for the clearing member’s proprietary activities). If the clearing member’s collateral and its client’s collateral are held in the same default fund contribution account, then the EAD of that account is the sum of the EAD for the client-related transactions within the account and the EAD of the house-related transactions within the account. For purposes of determining such EADs, the independent collateral of the clearing member and its client must be allocated in proportion to the respective total amount of independent collateral posted by the clearing member to the QCCP. (v) If any account or sub-account contains both derivative contracts and repo-style transactions, the EAD of that account is the sum of the EAD for the derivative contracts within the account and the EAD of the repo-style transactions within the account. If independent collateral is held for an account containing both derivative contracts and repo-style transactions, then such collateral must be allocated to the derivative contracts and repo-style transactions in proportion to the respective product specific exposure amounts, calculated, excluding the effects of collateral, according to § 217.132(b) for repo-style transactions and to § 217.132(c)(5) for derivative contracts. (vi) Notwithstanding any other provision of paragraph (d) of this section, with the prior approval of the Board, a Board-regulated institution may determine the risk-weighted asset amount for a default fund contribution to a QCCP according to § 217.35(d)(3)(ii). 24. Section 217.173 is amended in Table 13 to § 217.173 by revising line 4 under Part 2, Derivative exposures, to read as follows: ■ § 217.173 Disclosures by certain advanced approaches Board-regulated institutions and Category III Board-regulated institutions. * * * * * TABLE 13 TO § 217.173—SUPPLEMENTARY LEVERAGE RATIO Dollar amounts in thousands Tril * * * * Bil Mil Thou * * * * * * * * * lotter on DSKBCFDHB2PROD with RULES2 Part 2: Supplementary leverage ratio * * * * Derivative exposures * * * * 4 Current exposure for derivative exposures (that is, net of cash variation margin). VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 PO 00000 Frm 00068 Fmt 4701 Sfmt 4702 E:\FR\FM\24JAR2.SGM 24JAR2 4429 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations TABLE 13 TO § 217.173—SUPPLEMENTARY LEVERAGE RATIO—Continued Dollar amounts in thousands Tril * * * 25. Section 217.300 is amended by adding paragraph (h) and (i) to read as follows: ■ § 217.300 Transitions. * * * * * (h) SA–CCR. An advanced approaches Board-regulated institution may use CEM rather than SA–CCR for purposes of §§ 217.34(a) and 217.132(c) until January 1, 2022. A Board-regulated institution must provide prior notice to the Board if it decides to begin using SA–CCR before January 1, 2022. On January 1, 2022, and thereafter, an advanced approaches Board-regulated institution must use SA–CCR for purposes of §§ 217.34(a), 217.132(c), and 217.135(d). Once an advanced approaches Board-regulated institution has begun to use SA–CCR, the advanced approaches Board-regulated institution may not change to use CEM. (i) Default fund contributions. Prior to January 1, 2022, a Board-regulated institution that calculates the exposure amounts of its derivative contracts under the standardized approach for counterparty credit risk in § 217.132(c) may calculate the risk-weighted asset amount for a default fund contribution to a QCCP under either method 1 under § 217.35(d)(3)(i) or method 2 under § 217.35(d)(3)(ii), rather than under § 217.133(d). FEDERAL DEPOSIT INSURANCE CORPORATION For the reasons forth out in the preamble, 12 CFR parts 324 and 327 are amended as set forth below. PART 324—CAPITAL ADEQUACY OF FDIC-SUPERVISED INSTITUTIONS 26. The authority citation for part 324 continues to read as follows: lotter on DSKBCFDHB2PROD with RULES2 ■ Authority: 12 U.S.C. 1815(a), 1815(b), 1816, 1818(a), 1818(b), 1818(c), 1818(t), 1819(Tenth), 1828(c), 1828(d), 1828(i), 1828(n), 1828(o), 1831o, 1835, 3907, 3909, 4808; 5371; 5412; Pub. L. 102–233, 105 Stat. 1761, 1789, 1790 (12 U.S.C. 1831n note); Pub. L. 102–242, 105 Stat. 2236, 2355, as amended by Pub. L. 103–325, 108 Stat. 2160, 2233 (12 U.S.C. 1828 note); Pub. L. 102–242, 105 Stat. 2236, 2386, as amended by Pub. L. 102–550, 106 Stat. 3672, 4089 (12 U.S.C. 1828 note); Pub. L. 111–203, 124 Stat. 1376, 1887 (15 U.S.C. 78o–7 note). VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 * * 27. Section 324.2 is amended by: a. Adding the definitions of ‘‘Basis derivative contract,’’ ‘‘Client-facing derivative transaction,’’ and ‘‘Commercial end-user’’ in alphabetical order; ■ b. Revising the definition of ‘‘Current exposure’’ and ‘‘Current exposure methodology;’’ ■ c. Revising paragraph (2) of the definition of ‘‘Financial collateral;’’ ■ d. Adding the definitions of ‘‘Independent collateral,’’ ‘‘Minimum transfer amount,’’ and ‘‘Net independent collateral amount’’ in alphabetical order; ■ e. Revising the definition of ‘‘Netting set;’’ and ■ f. Adding the definitions of ‘‘Speculative grade,’’ ‘‘Sub-speculative grade,’’ ‘‘Variation margin,’’ ‘‘Variation margin agreement,’’ ‘‘Variation margin amount,’’ ‘‘Variation margin threshold,’’ and ‘‘Volatility derivative contract’’ in alphabetical order. The additions and revisions read as follows: ■ ■ § 324.2 Definitions. * * * * * Basis derivative contract means a nonforeign-exchange derivative contract (i.e., the contract is denominated in a single currency) in which the cash flows of the derivative contract depend on the difference between two risk factors that are attributable solely to one of the following derivative asset classes: Interest rate, credit, equity, or commodity. * * * * * Client-facing derivative transaction means a derivative contract that is not a cleared transaction where the FDICsupervised institution is either acting as a financial intermediary and enters into an offsetting transaction with a qualifying central counterparty (QCCP) or where the FDIC-supervised institution provides a guarantee to the QCCP on the performance of a client on a transaction between the client and a QCCP. * * * * * Commercial end-user means an entity that: (1)(i) Is using derivative contracts to hedge or mitigate commercial risk; and PO 00000 Frm 00069 Fmt 4701 Bil Sfmt 4702 Mil * Thou * (ii)(A) Is not an entity described in section 2(h)(7)(C)(i)(I) through (VIII) of the Commodity Exchange Act (7 U.S.C. 2(h)(7)(C)(i)(I) through (VIII)); or (B) Is not a ‘‘financial entity’’ for purposes of section 2(h)(7) of the Commodity Exchange Act (7 U.S.C. 2(h)) by virtue of section 2(h)(7)(C)(iii) of the Act (7 U.S.C. 2(h)(7)(C)(iii)); or (2)(i) Is using derivative contracts to hedge or mitigate commercial risk; and (ii) Is not an entity described in section 3C(g)(3)(A)(i) through (viii) of the Securities Exchange Act of 1934 (15 U.S.C. 78c–3(g)(3)(A)(i) through (viii)); or (3) Qualifies for the exemption in section 2(h)(7)(A) of the Commodity Exchange Act (7 U.S.C. 2(h)(7)(A)) by virtue of section 2(h)(7)(D) of the Act (7 U.S.C. 2(h)(7)(D)); or (4) Qualifies for an exemption in section 3C(g)(1) of the Securities Exchange Act of 1934 (15 U.S.C. 78c– 3(g)(1)) by virtue of section 3C(g)(4) of the Act (15 U.S.C. 78c–3(g)(4)). * * * * * Current exposure means, with respect to a netting set, the larger of zero or the fair value of a transaction or portfolio of transactions within the netting set that would be lost upon default of the counterparty, assuming no recovery on the value of the transactions. Current exposure methodology means the method of calculating the exposure amount for over-the-counter derivative contracts in § 324.34(b). * * * * * Financial collateral * * * (2) In which the FDIC-supervised institution has a perfected, first-priority security interest or, outside of the United States, the legal equivalent thereof (with the exception of cash on deposit; and notwithstanding the prior security interest of any custodial agent or any priority security interest granted to a CCP in connection with collateral posted to that CCP). * * * * * Independent collateral means financial collateral, other than variation margin, that is subject to a collateral agreement, or in which a FDICsupervised institution has a perfected, first-priority security interest or, outside of the United States, the legal equivalent thereof (with the exception of cash on E:\FR\FM\24JAR2.SGM 24JAR2 lotter on DSKBCFDHB2PROD with RULES2 4430 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations deposit; notwithstanding the prior security interest of any custodial agent or any prior security interest granted to a CCP in connection with collateral posted to that CCP), and the amount of which does not change directly in response to the value of the derivative contract or contracts that the financial collateral secures. * * * * * Minimum transfer amount means the smallest amount of variation margin that may be transferred between counterparties to a netting set pursuant to the variation margin agreement. * * * * * Net independent collateral amount means the fair value amount of the independent collateral, as adjusted by the standard supervisory haircuts under § 324.132(b)(2)(ii), as applicable, that a counterparty to a netting set has posted to a FDIC-supervised institution less the fair value amount of the independent collateral, as adjusted by the standard supervisory haircuts under § 324.132(b)(2)(ii), as applicable, posted by the FDIC-supervised institution to the counterparty, excluding such amounts held in a bankruptcy remote manner or posted to a QCCP and held in conformance with the operational requirements in § 324.3. Netting set means a group of transactions with a single counterparty that are subject to a qualifying master netting agreement. For derivative contracts, netting set also includes a single derivative contract between a FDIC-supervised institution and a single counterparty. For purposes of the internal model methodology under § 324.132(d), netting set also includes a group of transactions with a single counterparty that are subject to a qualifying cross-product master netting agreement and does not include a transaction: (1) That is not subject to such a master netting agreement; or (2) Where the FDIC-supervised institution has identified specific wrong-way risk. * * * * * Speculative grade means the reference entity has adequate capacity to meet financial commitments in the near term, but is vulnerable to adverse economic conditions, such that should economic conditions deteriorate, the reference entity would present an elevated default risk. * * * * * Sub-speculative grade means the reference entity depends on favorable economic conditions to meet its financial commitments, such that should such economic conditions VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 deteriorate the reference entity likely would default on its financial commitments. * * * * * Variation margin means financial collateral that is subject to a collateral agreement provided by one party to its counterparty to meet the performance of the first party’s obligations under one or more transactions between the parties as a result of a change in value of such obligations since the last time such financial collateral was provided. Variation margin agreement means an agreement to collect or post variation margin. Variation margin amount means the fair value amount of the variation margin, as adjusted by the standard supervisory haircuts under § 324.132(b)(2)(ii), as applicable, that a counterparty to a netting set has posted to a FDIC-supervised institution less the fair value amount of the variation margin, as adjusted by the standard supervisory haircuts under § 324.132(b)(2)(ii), as applicable, posted by the FDIC-supervised institution to the counterparty. Variation margin threshold means the amount of credit exposure of a FDICsupervised institution to its counterparty that, if exceeded, would require the counterparty to post variation margin to the FDIC-supervised institution pursuant to the variation margin agreement. Volatility derivative contract means a derivative contract in which the payoff of the derivative contract explicitly depends on a measure of the volatility of an underlying risk factor to the derivative contract. * * * * * ■ 28. Section 324.10 is amended by revising paragraphs (c)(4)(ii)(A) through (C) to read as follows: § 324.10 Minimum capital requirements. * * * * * (c) * * * (4) * * * (ii) * * * (A) The balance sheet carrying value of all of the FDIC-supervised institution’s on-balance sheet assets, plus the value of securities sold under a repurchase transaction or a securities lending transaction that qualifies for sales treatment under U.S. GAAP, less amounts deducted from tier 1 capital under § 324.22(a), (c), and (d), and less the value of securities received in security-for-security repo-style transactions, where the FDIC-supervised institution acts as a securities lender and includes the securities received in its on-balance sheet assets but has not PO 00000 Frm 00070 Fmt 4701 Sfmt 4702 sold or re-hypothecated the securities received, and, for a FDIC-supervised institution that uses the standardized approach for counterparty credit risk under § 324.132(c) for its standardized risk-weighted assets, less the fair value of any derivative contracts; (B)(1) For a FDIC-supervised institution that uses the current exposure methodology under § 324.34(b) for its standardized riskweighted assets, the potential future credit exposure (PFE) for each derivative contract or each singleproduct netting set of derivative contracts (including a cleared transaction except as provided in paragraph (c)(4)(ii)(I) of this section and, at the discretion of the FDIC-supervised institution, excluding a forward agreement treated as a derivative contract that is part of a repurchase or reverse repurchase or a securities borrowing or lending transaction that qualifies for sales treatment under U.S. GAAP), to which the FDIC-supervised institution is a counterparty as determined under § 324.34, but without regard to § 324.34(b), provided that: (i) A FDIC-supervised institution may choose to exclude the PFE of all credit derivatives or other similar instruments through which it provides credit protection when calculating the PFE under § 324.34, but without regard to § 324.34(b), provided that it does not adjust the net-to-gross ratio (NGR); and (ii) A FDIC-supervised institution that chooses to exclude the PFE of credit derivatives or other similar instruments through which it provides credit protection pursuant to paragraph (c)(4)(ii)(B)(1) of this section must do so consistently over time for the calculation of the PFE for all such instruments; or (2)(i) For a FDIC-supervised institution that uses the standardized approach for counterparty credit risk under section § 324.132(c) for its standardized risk-weighted assets, the PFE for each netting set to which the FDIC-supervised institution is a counterparty (including cleared transactions except as provided in paragraph (c)(4)(ii)(I) of this section and, at the discretion of the FDIC-supervised institution, excluding a forward agreement treated as a derivative contract that is part of a repurchase or reverse repurchase or a securities borrowing or lending transaction that qualifies for sales treatment under U.S. GAAP), as determined under § 324.132(c)(7), in which the term C in § 324.132(c)(7)(i) equals zero except as provided in paragraph (c)(4)(ii)(B)(2)(ii) of this section, and, for any counterparty E:\FR\FM\24JAR2.SGM 24JAR2 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations lotter on DSKBCFDHB2PROD with RULES2 that is not a commercial end-user, multiplied by 1.4; and (ii) For purposes of paragraph (c)(4)(ii)(B)(2)(i) of this section, a FDICsupervised institution may set the value of the term C in § 324.132(c)(7)(i) equal to the amount of collateral posted by a clearing member client of the FDICsupervised institution in connection with the client-facing derivative transactions within the netting set; (C)(1)(i) For a FDIC-supervised institution that uses the current exposure methodology under § 324.34(b) for its standardized riskweighted assets, the amount of cash collateral that is received from a counterparty to a derivative contract and that has offset the mark-to-fair value of the derivative asset, or cash collateral that is posted to a counterparty to a derivative contract and that has reduced the FDIC-supervised institution’s onbalance sheet assets, unless such cash collateral is all or part of variation margin that satisfies the conditions in paragraphs (c)(4)(ii)(C)(3) through (7) of this section; and (ii) The variation margin is used to reduce the current credit exposure of the derivative contract, calculated as described in § 324.34(b), and not the PFE; and (iii) For the purpose of the calculation of the NGR described in § 324.34(b)(2)(ii)(B), variation margin described in paragraph (c)(4)(ii)(C)(1)(ii) of this section may not reduce the net current credit exposure or the gross current credit exposure; or (2)(i) For a FDIC-supervised institution that uses the standardized approach for counterparty credit risk under § 324.132(c) for its standardized risk-weighted assets, the replacement cost of each derivative contract or single product netting set of derivative contracts to which the FDIC-supervised institution is a counterparty, calculated according to the following formula, and, for any counterparty that is not a commercial end-user, multiplied by 1.4: Replacement Cost = max{V¥CVMr + CVMp; 0} Where: V equals the fair value for each derivative contract or each single-product netting set of derivative contracts (including a cleared transaction except as provided in paragraph (c)(4)(ii)(I) of this section and, at the discretion of the FDIC-supervised institution, excluding a forward agreement treated as a derivative contract that is part of a repurchase or reverse repurchase or a securities borrowing or lending transaction that qualifies for sales treatment under U.S. GAAP); CVMr equals the amount of cash collateral received from a counterparty to a VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 derivative contract and that satisfies the conditions in paragraphs (c)(4)(ii)(C)(3) through (7) of this section, or, in the case of a client-facing derivative transaction on behalf of a clearing member client, the amount of collateral received from the clearing member client; and CVMp equals the amount of cash collateral that is posted to a counterparty to a derivative contract and that has not offset the fair value of the derivative contract and that satisfies the conditions in paragraphs (c)(4)(ii)(C)(3) through (7) of this section, or, in the case of a clientfacing derivative transaction on behalf of a clearing member client, the amount of collateral posted to the clearing member client; (ii) Notwithstanding paragraph (c)(4)(ii)(C)(2)(i) of this section, where multiple netting sets are subject to a single variation margin agreement, a FDIC-supervised institution must apply the formula for replacement cost provided in § 324.132(c)(10)(i), in which the term CMA may only include cash collateral that satisfies the conditions in paragraphs (c)(4)(ii)(C)(3) through (7) of this section; and (iii) For purposes of paragraph (c)(4)(ii)(C)(2)(i), a FDIC-supervised institution must treat a derivative contract that references an index as if it were multiple derivative contracts each referencing one component of the index if the FDIC-supervised institution elected to treat the derivative contract as multiple derivative contracts under § 324.132(c)(5)(vi); (3) For derivative contracts that are not cleared through a QCCP, the cash collateral received by the recipient counterparty is not segregated (by law, regulation, or an agreement with the counterparty); (4) Variation margin is calculated and transferred on a daily basis based on the mark-to-fair value of the derivative contract; (5) The variation margin transferred under the derivative contract or the governing rules of the CCP or QCCP for a cleared transaction is the full amount that is necessary to fully extinguish the net current credit exposure to the counterparty of the derivative contracts, subject to the threshold and minimum transfer amounts applicable to the counterparty under the terms of the derivative contract or the governing rules for a cleared transaction; (6) The variation margin is in the form of cash in the same currency as the currency of settlement set forth in the derivative contract, provided that for the purposes of this paragraph (c)(4)(ii)(C)(6), currency of settlement means any currency for settlement specified in the governing qualifying master netting agreement and the credit PO 00000 Frm 00071 Fmt 4701 Sfmt 4702 4431 support annex to the qualifying master netting agreement, or in the governing rules for a cleared transaction; and (7) The derivative contract and the variation margin are governed by a qualifying master netting agreement between the legal entities that are the counterparties to the derivative contract or by the governing rules for a cleared transaction, and the qualifying master netting agreement or the governing rules for a cleared transaction must explicitly stipulate that the counterparties agree to settle any payment obligations on a net basis, taking into account any variation margin received or provided under the contract if a credit event involving either counterparty occurs; * * * * * ■ 29. Section 324.32 is amended by revising paragraph (f) to read as follows: § 324.32 General risk weights. * * * * * (f) Corporate exposures. (1) A FDICsupervised institution must assign a 100 percent risk weight to all its corporate exposures, except as provided in paragraph (f)(2) of this section. (2) A FDIC-supervised institution must assign a 2 percent risk weight to an exposure to a QCCP arising from the FDIC-supervised institution posting cash collateral to the QCCP in connection with a cleared transaction that meets the requirements of § 324.35(b)(3)(i)(A) and a 4 percent risk weight to an exposure to a QCCP arising from the FDIC-supervised institution posting cash collateral to the QCCP in connection with a cleared transaction that meets the requirements of § 324.35(b)(3)(i)(B). (3) A FDIC-supervised institution must assign a 2 percent risk weight to an exposure to a QCCP arising from the FDIC-supervised institution posting cash collateral to the QCCP in connection with a cleared transaction that meets the requirements of § 324.35(c)(3)(i). * * * * * ■ 30. Section 324.34 is revised to read as follows: § 324.34 Derivative contracts. (a) Exposure amount for derivative contracts—(1) FDIC-supervised institution that is not an advanced approaches FDIC-supervised institution. (i) A FDIC-supervised institution that is not an advanced approaches FDICsupervised institution must use the current exposure methodology (CEM) described in paragraph (b) of this section to calculate the exposure amount for all its OTC derivative contracts, unless the FDIC-supervised E:\FR\FM\24JAR2.SGM 24JAR2 4432 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations institution makes the election provided in paragraph (a)(1)(ii) of this section. (ii) A FDIC-supervised institution that is not an advanced approaches FDICsupervised institution may elect to calculate the exposure amount for all its OTC derivative contracts under the standardized approach for counterparty credit risk (SA–CCR) in § 324.132(c) by notifying the FDIC, rather than calculating the exposure amount for all its derivative contracts using CEM. A FDIC-supervised institution that elects under this paragraph (a)(1)(ii) to calculate the exposure amount for its OTC derivative contracts under SA–CCR must apply the treatment of cleared transactions under § 324.133 to its derivative contracts that are cleared transactions and to all default fund contributions associated with such derivative contracts, rather than applying § 324.35. A FDIC-supervised institution that is not an advanced approaches FDIC-supervised institution must use the same methodology to calculate the exposure amount for all its derivative contracts and, if a FDICsupervised institution has elected to use SA–CCR under this paragraph (a)(1)(ii), the FDIC-supervised institution may change its election only with prior approval of the FDIC. (2) Advanced approaches FDICsupervised institution. An advanced derivative contract by the appropriate conversion factor in Table 1 to this section. (B) For purposes of calculating either the PFE under this paragraph (b)(1)(ii) or the gross PFE under paragraph (b)(2)(ii)(A) of this section for exchange rate contracts and other similar contracts in which the notional principal amount is equivalent to the cash flows, notional principal amount is the net receipts to each party falling due on each value date in each currency. (C) For an OTC derivative contract that does not fall within one of the specified categories in Table 1 to this section, the PFE must be calculated using the appropriate ‘‘other’’ conversion factor. (D) A FDIC-supervised institution must use an OTC derivative contract’s effective notional principal amount (that is, the apparent or stated notional principal amount multiplied by any multiplier in the OTC derivative contract) rather than the apparent or stated notional principal amount in calculating PFE. (E) The PFE of the protection provider of a credit derivative is capped at the net present value of the amount of unpaid premiums. approaches FDIC-supervised institution must calculate the exposure amount for all its derivative contracts using SA– CCR in § 324.132(c) for purposes of standardized total risk-weighted assets. An advanced approaches FDICsupervised institution must apply the treatment of cleared transactions under § 324.133 to its derivative contracts that are cleared transactions and to all default fund contributions associated with such derivative contracts for purposes of standardized total riskweighted assets. (b) Current exposure methodology exposure amount—(1) Single OTC derivative contract. Except as modified by paragraph (c) of this section, the exposure amount for a single OTC derivative contract that is not subject to a qualifying master netting agreement is equal to the sum of the FDIC-supervised institution’s current credit exposure and potential future credit exposure (PFE) on the OTC derivative contract. (i) Current credit exposure. The current credit exposure for a single OTC derivative contract is the greater of the fair value of the OTC derivative contract or zero. (ii) PFE. (A) The PFE for a single OTC derivative contract, including an OTC derivative contract with a negative fair value, is calculated by multiplying the notional principal amount of the OTC TABLE 1 TO § 324.34—CONVERSION FACTOR MATRIX FOR DERIVATIVE CONTRACTS 1 Remaining maturity 2 Foreign exchange rate and gold Interest rate One year or less ........................................... Greater than one year and less than or equal to five years ..................................... Greater than five years ................................. Credit (noninvestmentgrade reference asset) Credit (investment grade reference asset) 3 Precious metals (except gold) Equity Other 0.00 0.01 0.05 0.10 0.06 0.07 0.10 0.005 0.015 0.05 0.075 0.05 0.05 0.10 0.10 0.08 0.10 0.07 0.08 0.12 0.15 1 For a derivative contract with multiple exchanges of principal, the conversion factor is multiplied by the number of remaining payments in the derivative contract. an OTC derivative contract that is structured such that on specified dates any outstanding exposure is settled and the terms are reset so that the fair value of the contract is zero, the remaining maturity equals the time until the next reset date. For an interest rate derivative contract with a remaining maturity of greater than one year that meets these criteria, the minimum conversion factor is 0.005. 3 A FDIC-supervised institution must use the column labeled ‘‘Credit (investment-grade reference asset)’’ for a credit derivative whose reference asset is an outstanding unsecured long-term debt security without credit enhancement that is investment grade. A FDIC-supervised institution must use the column labeled ‘‘Credit (non-investment-grade reference asset)’’ for all other credit derivatives. lotter on DSKBCFDHB2PROD with RULES2 2 For (2) Multiple OTC derivative contracts subject to a qualifying master netting agreement. Except as modified by paragraph (c) of this section, the exposure amount for multiple OTC derivative contracts subject to a qualifying master netting agreement is equal to the sum of the net current credit exposure and the adjusted sum of the PFE amounts for all OTC derivative contracts subject to the qualifying master netting agreement. (i) Net current credit exposure. The net current credit exposure is the greater of the net sum of all positive and VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 negative fair values of the individual OTC derivative contracts subject to the qualifying master netting agreement or zero. (ii) Adjusted sum of the PFE amounts. The adjusted sum of the PFE amounts, Anet, is calculated as Anet = (0.4 × Agross) + (0.6 × NGR × Agross), where: (A) Agross = the gross PFE (that is, the sum of the PFE amounts as determined under paragraph (b)(1)(ii) of this section for each individual derivative contract subject to the qualifying master netting agreement); and (B) Net-to-gross Ratio (NGR) = the ratio of the net current credit exposure PO 00000 Frm 00072 Fmt 4701 Sfmt 4702 to the gross current credit exposure. In calculating the NGR, the gross current credit exposure equals the sum of the positive current credit exposures (as determined under paragraph (b)(1)(i) of this section) of all individual derivative contracts subject to the qualifying master netting agreement. (c) Recognition of credit risk mitigation of collateralized OTC derivative contracts. (1) A FDICsupervised institution using CEM under paragraph (b) of this section may recognize the credit risk mitigation benefits of financial collateral that E:\FR\FM\24JAR2.SGM 24JAR2 secures an OTC derivative contract or multiple OTC derivative contracts subject to a qualifying master netting agreement (netting set) by using the simple approach in § 324.37(b). (2) As an alternative to the simple approach, a FDIC-supervised institution using CEM under paragraph (b) of this section may recognize the credit risk mitigation benefits of financial collateral that secures such a contract or netting set if the financial collateral is markedto-fair value on a daily basis and subject to a daily margin maintenance requirement by applying a risk weight to the uncollateralized portion of the exposure, after adjusting the exposure amount calculated under paragraph (b)(1) or (2) of this section using the collateral haircut approach in § 324.37(c). The FDIC-supervised institution must substitute the exposure amount calculated under paragraph (b)(1) or (2) of this section for SE in the equation in § 324.37(c)(2). (d) Counterparty credit risk for credit derivatives—(1) Protection purchasers. A FDIC-supervised institution that purchases a credit derivative that is recognized under § 324.36 as a credit risk mitigant for an exposure that is not a covered position under subpart F of this part is not required to compute a separate counterparty credit risk capital requirement under this subpart provided that the FDIC-supervised institution does so consistently for all such credit derivatives. The FDICsupervised institution must either include all or exclude all such credit derivatives that are subject to a qualifying master netting agreement from any measure used to determine counterparty credit risk exposure to all relevant counterparties for risk-based capital purposes. (2) Protection providers. (i) A FDICsupervised institution that is the protection provider under a credit derivative must treat the credit derivative as an exposure to the underlying reference asset. The FDICsupervised institution is not required to compute a counterparty credit risk capital requirement for the credit derivative under this subpart, provided that this treatment is applied consistently for all such credit derivatives. The FDIC-supervised institution must either include all or exclude all such credit derivatives that are subject to a qualifying master netting agreement from any measure used to determine counterparty credit risk exposure. (ii) The provisions of this paragraph (d)(2) apply to all relevant counterparties for risk-based capital purposes unless the FDIC-supervised VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 institution is treating the credit derivative as a covered position under subpart F of this part, in which case the FDIC-supervised institution must compute a supplemental counterparty credit risk capital requirement under this section. (e) Counterparty credit risk for equity derivatives. (1) A FDIC-supervised institution must treat an equity derivative contract as an equity exposure and compute a risk-weighted asset amount for the equity derivative contract under §§ 324.51 through 324.53 (unless the FDIC-supervised institution is treating the contract as a covered position under subpart F of this part). (2) In addition, the FDIC-supervised institution must also calculate a riskbased capital requirement for the counterparty credit risk of an equity derivative contract under this section if the FDIC-supervised institution is treating the contract as a covered position under subpart F of this part. (3) If the FDIC-supervised institution risk weights the contract under the Simple Risk-Weight Approach (SRWA) in § 324.52, the FDIC-supervised institution may choose not to hold riskbased capital against the counterparty credit risk of the equity derivative contract, as long as it does so for all such contracts. Where the equity derivative contracts are subject to a qualified master netting agreement, a FDIC-supervised institution using the SRWA must either include all or exclude all of the contracts from any measure used to determine counterparty credit risk exposure. (f) Clearing member FDIC-supervised institution’s exposure amount. The exposure amount of a clearing member FDIC-supervised institution using CEM under paragraph (b) of this section for a client-facing derivative transaction or netting set of client-facing derivative transactions equals the exposure amount calculated according to paragraph (b)(1) or (2) of this section multiplied by the scaling factor the square root of 1⁄2 (which equals 0.707107). If the FDIC-supervised institution determines that a longer period is appropriate, the FDICsupervised institution must use a larger scaling factor to adjust for a longer holding period as follows: Scaling factor = /H ✓w Where H = the holding period greater than or equal to five days. Additionally, the FDIC may require the FDICsupervised institution to set a longer holding period if the FDIC determines PO 00000 Frm 00073 Fmt 4701 Sfmt 4702 4433 that a longer period is appropriate due to the nature, structure, or characteristics of the transaction or is commensurate with the risks associated with the transaction. ■ 31. Section 324.35 is amended by adding paragraph (a)(3), revising paragraph (b)(4)(i), and adding paragraph (c)(3)(iii) to read as follows: § 324.35 Cleared transactions. (a) * * * (3) Alternate requirements. Notwithstanding any other provision of this section, an advanced approaches FDIC-supervised institution or a FDICsupervised institution that is not an advanced approaches FDIC-supervised institution and that has elected to use SA–CCR under § 324.34(a)(1) must apply § 324.133 to its derivative contracts that are cleared transactions rather than this section. (b) * * * (4) * * * (i) Notwithstanding any other requirements in this section, collateral posted by a clearing member client FDIC-supervised institution that is held by a custodian (in its capacity as custodian) in a manner that is bankruptcy remote from the CCP, clearing member, and other clearing member clients of the clearing member, is not subject to a capital requirement under this section. * * * * * (c) * * * (3) * * * (iii) Notwithstanding paragraphs (c)(3)(i) and (ii) of this section, a clearing member FDIC-supervised institution may apply a risk weight of zero percent to the trade exposure amount for a cleared transaction with a CCP where the clearing member FDICsupervised institution is acting as a financial intermediary on behalf of a clearing member client, the transaction offsets another transaction that satisfies the requirements set forth in § 324.3(a), and the clearing member FDICsupervised institution is not obligated to reimburse the clearing member client in the event of the CCP default. * * * * * ■ 32. Section 324.37 is amended by revising paragraphs (c)(3)(iii), (c)(3)(iv)(A) and (C), (c)(4)(i)(B) introductory text, and (c)(4)(i)(B)(1) to read as follows: § 324.37 Collateralized transactions. * * * * * (c) * * * (3) * * * (iii) For repo-style transactions and client-facing derivative transactions, a E:\FR\FM\24JAR2.SGM 24JAR2 ER24JA20.036</GPH> lotter on DSKBCFDHB2PROD with RULES2 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4434 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations FDIC-supervised institution may multiply the standard supervisory haircuts provided in paragraphs (c)(3)(i) and (ii) of this section by the square root of 1⁄2 (which equals 0.707107). For client-facing derivative transactions, if a larger scaling factor is applied under § 324.34(f), the same factor must be used to adjust the supervisory haircuts. (iv) * * * (A) TM equals a holding period of longer than 10 business days for eligible margin loans and derivative contracts other than client-facing derivative transactions or longer than 5 business days for repo-style transactions and client-facing derivative transactions; * * * * * (C) TS equals 10 business days for eligible margin loans and derivative contracts other than client-facing derivative transactions or 5 business days for repo-style transactions and client-facing derivative transactions. * * * * * (4) * * * (i) * * * (B) The minimum holding period for a repo-style transaction and clientfacing derivative transaction is five business days and for an eligible margin loan and a derivative contract other than a client-facing derivative transaction is ten business days except for transactions or netting sets for which paragraph (c)(4)(i)(C) of this section applies. When a FDIC-supervised institution calculates an own-estimates haircut on a TN-day holding period, which is different from the minimum holding period for the transaction type, the applicable haircut (HM) is calculated using the following square root of time formula: * * * * * (1) TM equals 5 for repo-style transactions and client-facing derivative transactions and 10 for eligible margin loans and derivative contracts other than client-facing derivative transactions; * * * * * §§ 324.134, 324.202, and 324.210 [Amended] 33. For each section listed in the following table, the footnote number listed in the ‘‘Old footnote number’’ column is redesignated as the footnote number listed in the ‘‘New footnote number’’ column as follows: ■ Old footnote number Section 324.134(d)(3) ........................................................................................................................................................... 324.202, paragraph (1) introductory text of the definition of ‘‘Covered position’’ ................................................... 324.202, paragraph (1)(i) of the definition of ‘‘Covered position’’ ........................................................................... 324.210(e)(1) ........................................................................................................................................................... 34. Section 324.132 is amended by: a. Revising paragraphs (b)(2)(ii)(A)(3) through (5); ■ b. Adding paragraphs (b)(2)(ii)(A)(6) and (7); ■ c. Revising paragraphs (c) heading and (c)(1) and (2) and (5) through (8); ■ d. Adding paragraphs (c)(9) through (11); ■ e. Revising paragraph (d)(10)(i); ■ f. In paragraphs (e)(5)(i)(A) and (H), removing ‘‘Table 3 to § 324.132’’ and adding in its pace ‘‘Table 4 to this section’’; ■ g. In paragraphs (e)(5)(i)(C) and (e)(6)(i)(B), removing ‘‘current exposure methodology’’ and adding in its place ‘‘standardized approach for counterparty credit risk’’ wherever it appears; ■ h. Redesignating Table 3 to § 324.132 following paragraph (e)(5)(ii) as Table 4 to § 324.132; and ■ i. Revising paragraph (e)(6)(viii). The revisions and additions read as follows: ■ ■ § 324.132 Counterparty credit risk of repostyle transactions, eligible margin loans, and OTC derivative contracts. lotter on DSKBCFDHB2PROD with RULES2 * * * * * (b) * * * (2) * * * (ii) * * * (A) * * * (3) For repo-style transactions and client-facing derivative transactions, a FDIC-supervised institution may multiply the supervisory haircuts VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 provided in paragraphs (b)(2)(ii)(A)(1) and (2) of this section by the square root of 1⁄2 (which equals 0.707107). If the FDIC-supervised institution determines that a longer holding period is appropriate for client-facing derivative transactions, then it must use a larger scaling factor to adjust for the longer holding period pursuant to paragraph (b)(2)(ii)(A)(6) of this section. (4) A FDIC-supervised institution must adjust the supervisory haircuts upward on the basis of a holding period longer than ten business days (for eligible margin loans) or five business days (for repo-style transactions), using the formula provided in paragraph (b)(2)(ii)(A)(6) of this section where the conditions in this paragraph (b)(2)(ii)(A)(4) apply. If the number of trades in a netting set exceeds 5,000 at any time during a quarter, a FDICsupervised institution must adjust the supervisory haircuts upward on the basis of a minimum holding period of twenty business days for the following quarter (except when a FDIC-supervised institution is calculating EAD for a cleared transaction under § 324.133). If a netting set contains one or more trades involving illiquid collateral, a FDICsupervised institution must adjust the supervisory haircuts upward on the basis of a minimum holding period of twenty business days. If over the two previous quarters more than two margin disputes on a netting set have occurred that lasted longer than the holding PO 00000 Frm 00074 Fmt 4701 Sfmt 4702 30 31 32 33 New footnote number 31 32 33 34 period, then the FDIC-supervised institution must adjust the supervisory haircuts upward for that netting set on the basis of a minimum holding period that is at least two times the minimum holding period for that netting set. (5)(i) A FDIC-supervised institution must adjust the supervisory haircuts upward on the basis of a holding period longer than ten business days for collateral associated with derivative contracts (five business days for clientfacing derivative contracts) using the formula provided in paragraph (b)(2)(ii)(A)(6) of this section where the conditions in this paragraph (b)(2)(ii)(A)(5)(i) apply. For collateral associated with a derivative contract that is within a netting set that is composed of more than 5,000 derivative contracts that are not cleared transactions, a FDIC-supervised institution must use a minimum holding period of twenty business days. If a netting set contains one or more trades involving illiquid collateral or a derivative contract that cannot be easily replaced, a FDIC-supervised institution must use a minimum holding period of twenty business days. (ii) Notwithstanding paragraph (b)(2)(ii)(A)(1) or (3) or (b)(2)(ii)(A)(5)(i) of this section, for collateral associated with a derivative contract in a netting set under which more than two margin disputes that lasted longer than the holding period occurred during the two previous quarters, the minimum holding E:\FR\FM\24JAR2.SGM 24JAR2 period is twice the amount provided under paragraph (b)(2)(ii)(A)(1) or (3) or (b)(2)(ii)(A)(5)(i) of this section. (6) A FDIC-supervised institution must adjust the standard supervisory haircuts upward, pursuant to the adjustments provided in paragraphs (b)(2)(ii)(A)(3) through (5) of this section, using the following formula: lotter on DSKBCFDHB2PROD with RULES2 Where: TM equals a holding period of longer than 10 business days for eligible margin loans and derivative contracts other than client-facing derivative transactions or longer than 5 business days for repostyle transactions and client-facing derivative transactions; Hs equals the standard supervisory haircut; and Ts equals 10 business days for eligible margin loans and derivative contracts other than client-facing derivative transactions or 5 business days for repostyle transactions and client-facing derivative transactions. (7) If the instrument a FDICsupervised institution has lent, sold subject to repurchase, or posted as collateral does not meet the definition of financial collateral, the FDIC-supervised institution must use a 25.0 percent haircut for market price volatility (Hs). * * * * * (c) EAD for derivative contracts—(1) Options for determining EAD. A FDICsupervised institution must determine the EAD for a derivative contract using the standardized approach for counterparty credit risk (SA–CCR) under paragraph (c)(5) of this section or using the internal models methodology described in paragraph (d) of this section. If a FDIC-supervised institution elects to use SA–CCR for one or more derivative contracts, the exposure amount determined under SA–CCR is the EAD for the derivative contract or derivatives contracts. A FDICsupervised institution must use the same methodology to calculate the exposure amount for all its derivative contracts and may change its election only with prior approval of the FDIC. A FDIC-supervised institution may reduce the EAD calculated according to paragraph (c)(5) of this section by the credit valuation adjustment that the FDIC-supervised institution has recognized in its balance sheet valuation of any derivative contracts in the netting set. For purposes of this paragraph (c)(1), the credit valuation adjustment VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 does not include any adjustments to common equity tier 1 capital attributable to changes in the fair value of the FDIC-supervised institution’s liabilities that are due to changes in its own credit risk since the inception of the transaction with the counterparty. (2) Definitions. For purposes of this paragraph (c) of this section, the following definitions apply: (i) End date means the last date of the period referenced by an interest rate or credit derivative contract or, if the derivative contract references another instrument, by the underlying instrument, except as otherwise provided in paragraph (c) of this section. (ii) Start date means the first date of the period referenced by an interest rate or credit derivative contract or, if the derivative contract references the value of another instrument, by underlying instrument, except as otherwise provided in paragraph (c) of this section. (iii) Hedging set means: (A) With respect to interest rate derivative contracts, all such contracts within a netting set that reference the same reference currency; (B) With respect to exchange rate derivative contracts, all such contracts within a netting set that reference the same currency pair; (C) With respect to credit derivative contract, all such contracts within a netting set; (D) With respect to equity derivative contracts, all such contracts within a netting set; (E) With respect to a commodity derivative contract, all such contracts within a netting set that reference one of the following commodity categories: Energy, metal, agricultural, or other commodities; (F) With respect to basis derivative contracts, all such contracts within a netting set that reference the same pair of risk factors and are denominated in the same currency; or (G) With respect to volatility derivative contracts, all such contracts within a netting set that reference one of interest rate, exchange rate, credit, equity, or commodity risk factors, separated according to the requirements under paragraphs (c)(2)(iii)(A) through (E) of this section. (H) If the risk of a derivative contract materially depends on more than one of interest rate, exchange rate, credit, equity, or commodity risk factors, the FDIC may require a FDIC-supervised institution to include the derivative contract in each appropriate hedging set PO 00000 Frm 00075 Fmt 4701 Sfmt 4702 4435 under paragraphs (c)(2)(iii)(A) through (E) of this section. * * * * * (5) Exposure amount. (i) The exposure amount of a netting set, as calculated under paragraph (c) of this section, is equal to 1.4 multiplied by the sum of the replacement cost of the netting set, as calculated under paragraph (c)(6) of this section, and the potential future exposure of the netting set, as calculated under paragraph (c)(7) of this section. (ii) Notwithstanding the requirements of paragraph (c)(5)(i) of this section, the exposure amount of a netting set subject to a variation margin agreement, excluding a netting set that is subject to a variation margin agreement under which the counterparty to the variation margin agreement is not required to post variation margin, is equal to the lesser of the exposure amount of the netting set calculated under paragraph (c)(5)(i) of this section and the exposure amount of the netting set calculated as if the netting set were not subject to a variation margin agreement. (iii) Notwithstanding the requirements of paragraph (c)(5)(i) of this section, the exposure amount of a netting set that consists of only sold options in which the premiums have been fully paid by the counterparty to the options and where the options are not subject to a variation margin agreement is zero. (iv) Notwithstanding the requirements of paragraph (c)(5)(i) of this section, the exposure amount of a netting set in which the counterparty is a commercial end-user is equal to the sum of replacement cost, as calculated under paragraph (c)(6) of this section, and the potential future exposure of the netting set, as calculated under paragraph (c)(7) of this section. (v) For purposes of the exposure amount calculated under paragraph (c)(5)(i) of this section and all calculations that are part of that exposure amount, a FDIC-supervised institution may elect, at the netting set level, to treat a derivative contract that is a cleared transaction that is not subject to a variation margin agreement as one that is subject to a variation margin agreement, if the derivative contract is subject to a requirement that the counterparties make daily cash payments to each other to account for changes in the fair value of the derivative contract and to reduce the net position of the contract to zero. If a FDIC-supervised institution makes an election under this paragraph (c)(5)(v) for one derivative contract, it must treat all other derivative contracts within the same netting set that are eligible for an E:\FR\FM\24JAR2.SGM 24JAR2 ER24JA20.037</GPH> Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4436 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations election under this paragraph (c)(5)(v) as derivative contracts that are subject to a variation margin agreement. (vi) For purposes of the exposure amount calculated under paragraph (c)(5)(i) of this section and all calculations that are part of that exposure amount, a FDIC-supervised institution may elect to treat a credit derivative contract, equity derivative contract, or commodity derivative contract that references an index as if it were multiple derivative contracts each referencing one component of the index. (6) Replacement cost of a netting set— (i) Netting set subject to a variation margin agreement under which the counterparty must post variation margin. The replacement cost of a netting set subject to a variation margin agreement, excluding a netting set that is subject to a variation margin agreement under which the counterparty is not required to post variation margin, is the greater of: (A) The sum of the fair values (after excluding any valuation adjustments) of the derivative contracts within the netting set less the sum of the net independent collateral amount and the variation margin amount applicable to such derivative contracts; (B) The sum of the variation margin threshold and the minimum transfer amount applicable to the derivative contracts within the netting set less the net independent collateral amount applicable to such derivative contracts; or (C) Zero. (ii) Netting sets not subject to a variation margin agreement under which the counterparty must post variation margin. The replacement cost of a netting set that is not subject to a variation margin agreement under which the counterparty must post variation margin to the FDIC-supervised institution is the greater of: (A) The sum of the fair values (after excluding any valuation adjustments) of the derivative contracts within the netting set less the sum of the net independent collateral amount and variation margin amount applicable to such derivative contracts; or PFE multiplier= min { 1; 0.05 Where: V is the sum of the fair values (after excluding any valuation adjustments) of the derivative contracts within the netting set; C is the sum of the net independent collateral amount and the variation margin amount applicable to the derivative contracts within the netting set; and A is the aggregated amount of the netting set. (ii) Aggregated amount. The aggregated amount is the sum of all hedging set amounts, as calculated under paragraph (c)(8) of this section, within a netting set. (B) Zero. (iii) Multiple netting sets subject to a single variation margin agreement. Notwithstanding paragraphs (c)(6)(i) and (ii) of this section, the replacement cost for multiple netting sets subject to a single variation margin agreement must be calculated according to paragraph (c)(10)(i) of this section. (iv) Netting set subject to multiple variation margin agreements or a hybrid netting set. Notwithstanding paragraphs (c)(6)(i) and (ii) of this section, the replacement cost for a netting set subject to multiple variation margin agreements or a hybrid netting set must be calculated according to paragraph (c)(11)(i) of this section. (7) Potential future exposure of a netting set. The potential future exposure of a netting set is the product of the PFE multiplier and the aggregated amount. (i) PFE multiplier. The PFE multiplier is calculated according to the following formula: + 0.95 * e(;;.~)} (iii) Multiple netting sets subject to a single variation margin agreement. Notwithstanding paragraphs (c)(7)(i) and (ii) of this section and when calculating the potential future exposure for purposes of total leverage exposure under § 324.10(c)(4)(ii)(B), the potential future exposure for multiple netting sets subject to a single variation margin agreement must be calculated according to paragraph (c)(10)(ii) of this section. (iv) Netting set subject to multiple variation margin agreements or a hybrid netting set. Notwithstanding paragraphs (c)(7)(i) and (ii) of this section and when calculating the potential future exposure Hedging set amount= [(AddOn~i 1 )2 for purposes of total leverage exposure under § 324.10(c)(4)(ii)(B), the potential future exposure for a netting set subject to multiple variation margin agreements or a hybrid netting set must be calculated according to paragraph (c)(11)(ii) of this section. (8) Hedging set amount—(i) Interest rate derivative contracts. To calculate the hedging set amount of an interest rate derivative contract hedging set, a FDIC-supervised institution may use either of the formulas provided in paragraphs (c)(8)(i)(A) and (B) of this section: (A) Formula 1 is as follows: + (AddOn~i 2 ) 2 + 1 (B) Formula 2 is as follows: Hedging set amount = |AddOnTB1IR| + |AddOnTB2IR + |AddOnTB3IR|. Where in paragraphs (c)(8)(i)(A) and (B) of this section: VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 AddOnTB1IR is the sum of the adjusted derivative contract amounts, as calculated under paragraph (c)(9) of this section, within the hedging set with an end date of less than one year from the present date; PO 00000 Frm 00076 Fmt 4701 Sfmt 4702 AddOnTB2IR is the sum of the adjusted derivative contract amounts, as calculated under paragraph (c)(9) of this section, within the hedging set with an end date of one to five years from the present date; and E:\FR\FM\24JAR2.SGM 24JAR2 ER24JA20.039</GPH> + 0.6 * AddOn~i 1 * Add0n~i 3 )]z; or ER24JA20.038</GPH> lotter on DSKBCFDHB2PROD with RULES2 Add0n~i 3 4437 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations Where: k is each reference entity within the hedging set. K is the number of reference entities within the hedging set. AddOn(Refk) equals the sum of the adjusted derivative contract amounts, as (iii) Credit derivative contracts and equity derivative contracts. The hedging set amount of a credit derivative contract hedging set or equity derivative contract hedging set within a netting set is calculated according to the following formula: determined under paragraph (c)(9) of this section, for all derivative contracts within the hedging set that reference reference entity k. rk equals the applicable supervisory correlation factor, as provided in Table 2 to this section. (iv) Commodity derivative contracts. The hedging set amount of a commodity derivative contract hedging set within a netting set is calculated according to the following formula: Hedging set amount= [(p Where: k is each commodity type within the hedging set. K is the number of commodity types within the hedging set. AddOn(Typek) equals the sum of the adjusted derivative contract amounts, as determined under paragraph (c)(9) of this section, for all derivative contracts within the hedging set that reference commodity type k. r equals the applicable supervisory correlation factor, as provided in Table 2 to this section. (v) Basis derivative contracts and volatility derivative contracts. Notwithstanding paragraphs (c)(8)(i) through (iv) of this section, a FDICsupervised institution must calculate a separate hedging set amount for each basis derivative contract hedging set and each volatility derivative contract hedging set. A FDIC-supervised institution must calculate such hedging set amounts using one of the formulas under paragraphs (c)(8)(i) through (iv) that corresponds to the primary risk factor of the hedging set being calculated. (9) Adjusted derivative contract amount—(i) Summary. To calculate the adjusted derivative contract amount of a derivative contract, a FDIC-supervised institution must determine the adjusted notional amount of derivative contract, pursuant to paragraph (c)(9)(ii) of this section, and multiply the adjusted lotter on DSKBCFDHB2PROD with RULES2 Supervisory duration Where: S is the number of business days from the present day until the start date of the derivative contract, or zero if the start date has already passed; and E is the number of business days from the present day until the end date of the derivative contract. (2) For purposes of paragraph (c)(9)(ii)(A)(1) of this section: (i) For an interest rate derivative contract or credit derivative contract VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 * IJ= 1 Add0n(Typek)) 2 + (1 - = max { e -0.05* (;; 0 ) _ PO 00000 Frm 00077 Fmt 4701 Sfmt 4702 * notional amount by each of the supervisory delta adjustment, pursuant to paragraph (c)(9)(iii) of this section, the maturity factor, pursuant to paragraph (c)(9)(iv) of this section, and the applicable supervisory factor, as provided in Table 2 to this section. (ii) Adjusted notional amount. (A)(1) For an interest rate derivative contract or a credit derivative contract, the adjusted notional amount equals the product of the notional amount of the derivative contract, as measured in U.S. dollars using the exchange rate on the date of the calculation, and the supervisory duration, as calculated by the following formula: -0.05* ( 2~ 0 )) e } , 0.05 that is a variable notional swap, the notional amount is equal to the timeweighted average of the contractual notional amounts of such a swap over the remaining life of the swap; and (ii) For an interest rate derivative contract or a credit derivative contract that is a leveraged swap, in which the notional amount of all legs of the derivative contract are divided by a factor and all rates of the derivative contract are multiplied by the same (p) 2 ) 0.04 factor, the notional amount is equal to the notional amount of an equivalent unleveraged swap. (B)(1) For an exchange rate derivative contract, the adjusted notional amount is the notional amount of the non-U.S. denominated currency leg of the derivative contract, as measured in U.S. dollars using the exchange rate on the date of the calculation. If both legs of the exchange rate derivative contract are denominated in currencies other than E:\FR\FM\24JAR2.SGM 24JAR2 ER24JA20.041</GPH> ER24JA20.042</GPH> (ii) Exchange rate derivative contracts. For an exchange rate derivative contract hedging set, the hedging set amount equals the absolute value of the sum of the adjusted derivative contract amounts, as calculated under paragraph (c)(9) of this section, within the hedging set. ER24JA20.040</GPH> AddOnTB3IR is the sum of the adjusted derivative contract amounts, as calculated under paragraph (c)(9) of this section, within the hedging set with an end date of more than five years from the present date. 4438 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations U.S. dollars, the adjusted notional amount of the derivative contract is the largest leg of the derivative contract, as measured in U.S. dollars using the exchange rate on the date of the calculation. (2) Notwithstanding paragraph (c)(9)(ii)(B)(1) of this section, for an exchange rate derivative contract with multiple exchanges of principal, the FDIC-supervised institution must set the adjusted notional amount of the derivative contract equal to the notional amount of the derivative contract multiplied by the number of exchanges of principal under the derivative contract. (C)(1) For an equity derivative contract or a commodity derivative contract, the adjusted notional amount is the product of the fair value of one unit of the reference instrument underlying the derivative contract and the number of such units referenced by the derivative contract. (2) Notwithstanding paragraph (c)(9)(ii)(C)(1) of this section, when calculating the adjusted notional amount for an equity derivative contract or a commodity derivative contract that is a volatility derivative contract, the FDIC-supervised institution must replace the unit price with the underlying volatility referenced by the volatility derivative contract and replace the number of units with the notional amount of the volatility derivative contract. (iii) Supervisory delta adjustments. (A) For a derivative contract that is not an option contract or collateralized debt obligation tranche, the supervisory delta adjustment is 1 if the fair value of the derivative contract increases when the value of the primary risk factor increases and ¥1 if the fair value of the derivative contract decreases when the value of the primary risk factor increases. (B)(1) For a derivative contract that is an option contract, the supervisory delta adjustment is determined by the following formulas, as applicable: Table 2 to §324.132--Supervisory Delta Adjustment for Options Contracts Sold Bought a • Put Opiom .ft T /250 o' • T a • JT /250 (2) As used in the formulas in Table 2 to this section: (i) F is the standard normal cumulative distribution function; (ii) P equals the current fair value of the instrument or risk factor, as applicable, underlying the option; (iii) K equals the strike price of the option; (iv) T equals the number of business days until the latest contractual exercise date of the option; (In~ tU+o.s • /250) •{ In' ti) JT /250) lotter on DSKBCFDHB2PROD with RULES2 30 In the case of a first-to-default credit derivative, there are no underlying exposures that are subordinated to the FDIC-supervised institution’s VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 a • +O.S• o' • (v) l equals zero for all derivative contracts except interest rate options for the currencies where interest rates have negative values. The same value of l must be used for all interest rate options that are denominated in the same currency. To determine the value of l for a given currency, a FDIC-supervised institution must find the lowest value L of P and K of all interest rate options in a given currency that the FDIC- = Fmt 4701 Sfmt 4702 supervised institution has with all counterparties. Then, l is set according to this formula: l = max{¥L + 0.1%, 0}; and (vi) s equals the supervisory option volatility, as provided in Table 3 to this section. (C)(1) For a derivative contract that is a collateralized debt obligation tranche, the supervisory delta adjustment is determined by the following formula: 15 exposure. In the case of a second-or-subsequent-todefault credit derivative, the smallest (n¥1) notional amounts of the underlying exposures are subordinated to the FDIC-supervised institution’s exposure. Frm 00078 T/2SO) /250 (1+14* A)*(1+14* D) (ii) D is the detachment point, which equals one minus the ratio of the notional amounts of all underlying exposures that are senior to the FDICsupervised institution’s exposure to the total notional amount of all underlying exposures, expressed as a decimal value between zero and one; and PO 00000 T/250) JT/250 a • Supervisory delta adjustment (2) As used in the formula in paragraph (c)(9)(iii)(C)(1) of this section: (i) A is the attachment point, which equals the ratio of the notional amounts of all underlying exposures that are subordinated to the FDIC-supervised institution’s exposure to the total notional amount of all underlying exposures, expressed as a decimal value between zero and one; 30 o' • -4> (iii) The resulting amount is designated with a positive sign if the collateralized debt obligation tranche was purchased by the FDIC-supervised institution and is designated with a negative sign if the collateralized debt obligation tranche was sold by the FDICsupervised institution. (iv) Maturity factor. (A)(1) The maturity factor of a derivative contract that is subject to a variation margin agreement, excluding derivative contracts that are subject to a variation E:\FR\FM\24JAR2.SGM 24JAR2 ER24JA20.044</GPH> •('·~ tU+o.s•.,. -•( In~ !i)+O.S• ER24JA20.043</GPH> Call Options Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations ~2 .JMPOR 250 Where MPOR refers to the period from the most recent exchange of collateral covering a netting set of derivative contracts with a defaulting counterparty until the derivative contracts are closed out and the resulting market risk is re-hedged. (2) Notwithstanding paragraph (c)(9)(iv)(A)(1) of this section: (i) For a derivative contract that is not a client-facing derivative transaction, MPOR cannot be less than ten business days plus the periodicity of remargining expressed in business days minus one business day; (ii) For a derivative contract that is a client-facing derivative transaction, MPOR cannot be less than five business days plus the periodicity of remargining expressed in business days minus one business day; and (iii) For a derivative contract that is within a netting set that is composed of more than 5,000 derivative contracts that are not cleared transactions, or a netting set that contains one or more trades involving illiquid collateral or a derivative contract that cannot be easily replaced, MPOR cannot be less than twenty business days. (3) Notwithstanding paragraphs (c)(9)(iv)(A)(1) and (2) of this section, for a netting set subject to two or more outstanding disputes over margin that lasted longer than the MPOR over the previous two quarters, the applicable floor is twice the amount provided in (c)(9)(iv)(A)(1) and (2) of this section. (B) The maturity factor of a derivative contract that is not subject to a variation margin agreement, or derivative contracts under which the counterparty is not required to post variation margin, is determined by the following formula: lotter on DSKBCFDHB2PROD with RULES2 Maturity factor = min{M;250} 250 Where M equals the greater of 10 business days and the remaining maturity of the contract, as measured in business days. (C) For purposes of paragraph (c)(9)(iv) of this section, if a FDICsupervised institution has elected pursuant to paragraph (c)(5)(v) of this section to treat a derivative contract that is a cleared transaction that is not subject to a variation margin agreement as one that is subject to a variation margin agreement, the Board-regulated VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 Replacement Cost = max{SNS max{VNS; 0} ¥ max{CMA; 0}; 0} + max{SNS min{VNS; 0} ¥ min{CMA; 0}; 0} PO 00000 Frm 00079 Fmt 4701 Sfmt 4702 Where: NS is each netting set subject to the variation margin agreement MA; VNS is the sum of the fair values (after excluding any valuation adjustments) of the derivative contracts within the netting set NS; and CMA is the sum of the net independent collateral amount and the variation margin amount applicable to the derivative contracts within the netting sets subject to the single variation margin agreement. (ii) Calculating potential future exposure. Notwithstanding paragraph (c)(5) of this section, a FDIC-supervised institution shall assign a single potential future exposure to multiple netting sets that are subject to a single variation margin agreement under which the counterparty must post variation margin equal to the sum of the potential future exposure of each such netting set, each calculated according to paragraph (c)(7) of this section as if such nettings sets were not subject to a variation margin agreement. (11) Netting set subject to multiple variation margin agreements or a hybrid netting set—(i) Calculating replacement cost. To calculate replacement cost for either a netting set subject to multiple variation margin agreements under which the counterparty to each variation margin agreement must post variation margin, or a netting set composed of at least one derivative contract subject to variation margin agreement under which the counterparty must post variation margin and at least one derivative contract that is not subject to such a variation margin agreement, the calculation for replacement cost is provided under paragraph (c)(6)(i) of this section, except that the variation margin threshold equals the sum of the variation margin thresholds of all variation margin agreements within the netting set and the minimum transfer amount equals the sum of the minimum transfer amounts of all the variation margin agreements within the netting set. (ii) Calculating potential future exposure. (A) To calculate potential future exposure for a netting set subject to multiple variation margin agreements under which the counterparty to each variation margin agreement must post variation margin, or a netting set composed of at least one derivative contract subject to variation margin agreement under which the counterparty to the derivative contract must post variation margin and at least one derivative contract that is not subject to such a variation margin agreement, a FDIC-supervised institution must divide the netting set E:\FR\FM\24JAR2.SGM 24JAR2 ER24JA20.046</GPH> Maturity factor= institution must treat the derivative contract as subject to a variation margin agreement with maturity factor as determined according to (c)(9)(iv)(A) of this section, and daily settlement does not change the end date of the period referenced by the derivative contract. (v) Derivative contract as multiple effective derivative contracts. A FDICsupervised institution must separate a derivative contract into separate derivative contracts, according to the following rules: (A) For an option where the counterparty pays a predetermined amount if the value of the underlying asset is above or below the strike price and nothing otherwise (binary option), the option must be treated as two separate options. For purposes of paragraph (c)(9)(iii)(B) of this section, a binary option with strike K must be represented as the combination of one bought European option and one sold European option of the same type as the original option (put or call) with the strikes set equal to 0.95 * K and 1.05 * K so that the payoff of the binary option is reproduced exactly outside the region between the two strikes. The absolute value of the sum of the adjusted derivative contract amounts of the bought and sold options is capped at the payoff amount of the binary option. (B) For a derivative contract that can be represented as a combination of standard option payoffs (such as collar, butterfly spread, calendar spread, straddle, and strangle), a FDICsupervised institution must treat each standard option component must be treated as a separate derivative contract. (C) For a derivative contract that includes multiple-payment options, (such as interest rate caps and floors), a FDIC-supervised institution may represent each payment option as a combination of effective single-payment options (such as interest rate caplets and floorlets). (D) A FDIC-supervised institution may not decompose linear derivative contracts (such as swaps) into components. (10) Multiple netting sets subject to a single variation margin agreement—(i) Calculating replacement cost. Notwithstanding paragraph (c)(6) of this section, a FDIC-supervised institution shall assign a single replacement cost to multiple netting sets that are subject to a single variation margin agreement under which the counterparty must post variation margin, calculated according to the following formula: ER24JA20.045</GPH> margin agreement under which the counterparty is not required to post variation margin, is determined by the following formula: 4439 4440 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations into sub-netting sets (as described in paragraph (c)(11)(ii)(B) of this section) and calculate the aggregated amount for each sub-netting set. The aggregated amount for the netting set is calculated as the sum of the aggregated amounts for the sub-netting sets. The multiplier is calculated for the entire netting set. (B) For purposes of paragraph (c)(11)(ii)(A) of this section, the netting set must be divided into sub-netting sets as follows: (1) All derivative contracts within the netting set that are not subject to a variation margin agreement or that are subject to a variation margin agreement under which the counterparty is not required to post variation margin form a single sub-netting set. The aggregated amount for this sub-netting set is calculated as if the netting set is not subject to a variation margin agreement. (2) All derivative contracts within the netting set that are subject to variation margin agreements in which the counterparty must post variation margin and that share the same value of the MPOR form a single sub-netting set. The aggregated amount for this sub-netting set is calculated as if the netting set is subject to a variation margin agreement, using the MPOR value shared by the derivative contracts within the netting set. TABLE 3 TO § 324.132—SUPERVISORY OPTION VOLATILITY, SUPERVISORY CORRELATION PARAMETERS, AND SUPERVISORY FACTORS FOR DERIVATIVE CONTRACTS Supervisory option volatility (percent) Asset class Subclass Type Interest rate ........................... Exchange rate ....................... Credit, single name ............... N/A ........................................ N/A ........................................ Investment grade .................. Speculative grade ................. Sub-speculative grade .......... Investment Grade ................. Speculative Grade ................ N/A ........................................ N/A ........................................ Energy ................................... N/A ........................................ N/A ........................................ N/A ........................................ N/A ........................................ N/A ........................................ N/A ........................................ N/A ........................................ N/A ........................................ N/A ........................................ Electricity ............................... Other ..................................... N/A ........................................ N/A ........................................ N/A ........................................ Credit, index .......................... Equity, single name .............. Equity, index ......................... Commodity ............................ Metals ................................... Agricultural ............................ Other ..................................... 50 15 100 100 100 80 80 120 75 150 70 70 70 70 Supervisory correlation factor (percent) N/A N/A 50 50 50 80 80 50 80 40 40 40 40 40 Supervisory factor 1 (percent) 0.50 4.0 0.46 1.3 6.0 0.38 1.06 32 20 40 18 18 18 18 lotter on DSKBCFDHB2PROD with RULES2 1 The applicable supervisory factor for basis derivative contract hedging sets is equal to one-half of the supervisory factor provided in this Table 3, and the applicable supervisory factor for volatility derivative contract hedging sets is equal to 5 times the supervisory factor provided in this Table 3. (d) * * * (10) * * * (i) With prior written approval of the FDIC, a FDIC-supervised institution may set EAD equal to a measure of counterparty credit risk exposure, such as peak EAD, that is more conservative than an alpha of 1.4 times the larger of EPEunstressed and EPEstressed for every counterparty whose EAD will be measured under the alternative measure of counterparty exposure. The FDICsupervised institution must demonstrate the conservatism of the measure of counterparty credit risk exposure used for EAD. With respect to paragraph (d)(10)(i) of this section: (A) For material portfolios of new OTC derivative products, the FDICsupervised institution may assume that the standardized approach for counterparty credit risk pursuant to paragraph (c) of this section meets the conservatism requirement of this section for a period not to exceed 180 days. (B) For immaterial portfolios of OTC derivative contracts, the FDICsupervised institution generally may assume that the standardized approach for counterparty credit risk pursuant to paragraph (c) of this section meets the VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 conservatism requirement of this section. * * * * * (e) * * * (6) * * * (viii) If a FDIC-supervised institution uses the standardized approach for counterparty credit risk pursuant to paragraph (c) of this section to calculate the EAD for any immaterial portfolios of OTC derivative contracts, the FDICsupervised institution must use that EAD as a constant EE in the formula for the calculation of CVA with the maturity equal to the maximum of: (A) Half of the longest maturity of a transaction in the netting set; and (B) The notional weighted average maturity of all transactions in the netting set. ■ 35. Section 324.133 is amended by revising paragraphs (a), (b)(1) through (3), (b)(4)(i), (c)(1) through (3), (c)(4)(i), and (d) to read as follows: § 324.133 Cleared transactions. (a) General requirements—(1) Clearing member clients. A FDICsupervised institution that is a clearing member client must use the methodologies described in paragraph PO 00000 Frm 00080 Fmt 4701 Sfmt 4702 (b) of this section to calculate riskweighted assets for a cleared transaction. (2) Clearing members. A FDICsupervised institution that is a clearing member must use the methodologies described in paragraph (c) of this section to calculate its risk-weighted assets for a cleared transaction and paragraph (d) of this section to calculate its risk-weighted assets for its default fund contribution to a CCP. (b) * * * (1) Risk-weighted assets for cleared transactions. (i) To determine the riskweighted asset amount for a cleared transaction, a FDIC-supervised institution that is a clearing member client must multiply the trade exposure amount for the cleared transaction, calculated in accordance with paragraph (b)(2) of this section, by the risk weight appropriate for the cleared transaction, determined in accordance with paragraph (b)(3) of this section. (ii) A clearing member client FDICsupervised institution’s total riskweighted assets for cleared transactions is the sum of the risk-weighted asset amounts for all of its cleared transactions. E:\FR\FM\24JAR2.SGM 24JAR2 lotter on DSKBCFDHB2PROD with RULES2 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations (2) Trade exposure amount. (i) For a cleared transaction that is a derivative contract or a netting set of derivative contracts, trade exposure amount equals the EAD for the derivative contract or netting set of derivative contracts calculated using the methodology used to calculate EAD for derivative contracts set forth in § 324.132(c) or (d), plus the fair value of the collateral posted by the clearing member client FDIC-supervised institution and held by the CCP or a clearing member in a manner that is not bankruptcy remote. When the FDICsupervised institution calculates EAD for the cleared transaction using the methodology in § 324.132(d), EAD equals EADunstressed. (ii) For a cleared transaction that is a repo-style transaction or netting set of repo-style transactions, trade exposure amount equals the EAD for the repostyle transaction calculated using the methodology set forth in § 324.132(b)(2) or (3) or (d), plus the fair value of the collateral posted by the clearing member client FDIC-supervised institution and held by the CCP or a clearing member in a manner that is not bankruptcy remote. When the FDIC-supervised institution calculates EAD for the cleared transaction under § 324.132(d), EAD equals EADunstressed. (3) Cleared transaction risk weights. (i) For a cleared transaction with a QCCP, a clearing member client FDICsupervised institution must apply a risk weight of: (A) 2 percent if the collateral posted by the FDIC-supervised institution to the QCCP or clearing member is subject to an arrangement that prevents any loss to the clearing member client FDICsupervised institution due to the joint default or a concurrent insolvency, liquidation, or receivership proceeding of the clearing member and any other clearing member clients of the clearing member; and the clearing member client FDIC-supervised institution has conducted sufficient legal review to conclude with a well-founded basis (and maintains sufficient written documentation of that legal review) that in the event of a legal challenge (including one resulting from an event of default or from liquidation, insolvency, or receivership proceedings) the relevant court and administrative authorities would find the arrangements to be legal, valid, binding, and enforceable under the law of the relevant jurisdictions. (B) 4 percent, if the requirements of paragraph (b)(3)(i)(A) of this section are not met. (ii) For a cleared transaction with a CCP that is not a QCCP, a clearing member client FDIC-supervised VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 institution must apply the risk weight applicable to the CCP under subpart D of this part. (4) * * * (i) Notwithstanding any other requirement of this section, collateral posted by a clearing member client FDIC-supervised institution that is held by a custodian (in its capacity as a custodian) in a manner that is bankruptcy remote from the CCP, clearing member, and other clearing member clients of the clearing member, is not subject to a capital requirement under this section. * * * * * (c) * * * (1) Risk-weighted assets for cleared transactions. (i) To determine the riskweighted asset amount for a cleared transaction, a clearing member FDICsupervised institution must multiply the trade exposure amount for the cleared transaction, calculated in accordance with paragraph (c)(2) of this section by the risk weight appropriate for the cleared transaction, determined in accordance with paragraph (c)(3) of this section. (ii) A clearing member FDICsupervised institution’s total riskweighted assets for cleared transactions is the sum of the risk-weighted asset amounts for all of its cleared transactions. (2) Trade exposure amount. A clearing member FDIC-supervised institution must calculate its trade exposure amount for a cleared transaction as follows: (i) For a cleared transaction that is a derivative contract or a netting set of derivative contracts, trade exposure amount equals the EAD calculated using the methodology used to calculate EAD for derivative contracts set forth in § 324.132(c) or (d), plus the fair value of the collateral posted by the clearing member FDIC-supervised institution and held by the CCP in a manner that is not bankruptcy remote. When the clearing member FDIC-supervised institution calculates EAD for the cleared transaction using the methodology in § 324.132(d), EAD equals EADunstressed. (ii) For a cleared transaction that is a repo-style transaction or netting set of repo-style transactions, trade exposure amount equals the EAD calculated under § 324.132(b)(2) or (3) or (d), plus the fair value of the collateral posted by the clearing member FDIC-supervised institution and held by the CCP in a manner that is not bankruptcy remote. When the clearing member FDICsupervised institution calculates EAD for the cleared transaction under § 324.132(d), EAD equals EADunstressed. PO 00000 Frm 00081 Fmt 4701 Sfmt 4702 4441 (3) Cleared transaction risk weights. (i) A clearing member FDIC-supervised institution must apply a risk weight of 2 percent to the trade exposure amount for a cleared transaction with a QCCP. (ii) For a cleared transaction with a CCP that is not a QCCP, a clearing member FDIC-supervised institution must apply the risk weight applicable to the CCP according to subpart D of this part. (iii) Notwithstanding paragraphs (c)(3)(i) and (ii) of this section, a clearing member FDIC-supervised institution may apply a risk weight of zero percent to the trade exposure amount for a cleared transaction with a QCCP where the clearing member FDICsupervised institution is acting as a financial intermediary on behalf of a clearing member client, the transaction offsets another transaction that satisfies the requirements set forth in § 324.3(a), and the clearing member FDICsupervised institution is not obligated to reimburse the clearing member client in the event of the QCCP default. (4) * * * (i) Notwithstanding any other requirement of this section, collateral posted by a clearing member FDICsupervised institution that is held by a custodian (in its capacity as a custodian) in a manner that is bankruptcy remote from the CCP, clearing member, and other clearing member clients of the clearing member, is not subject to a capital requirement under this section. * * * * * (d) Default fund contributions—(1) General requirement. A clearing member FDIC-supervised institution must determine the risk-weighted asset amount for a default fund contribution to a CCP at least quarterly, or more frequently if, in the opinion of the FDICsupervised institution or the FDIC, there is a material change in the financial condition of the CCP. (2) Risk-weighted asset amount for default fund contributions to nonqualifying CCPs. A clearing member FDIC-supervised institution’s riskweighted asset amount for default fund contributions to CCPs that are not QCCPs equals the sum of such default fund contributions multiplied by 1,250 percent, or an amount determined by the FDIC, based on factors such as size, structure, and membership characteristics of the CCP and riskiness of its transactions, in cases where such default fund contributions may be unlimited. (3) Risk-weighted asset amount for default fund contributions to QCCPs. A clearing member FDIC-supervised institution’s risk-weighted asset amount E:\FR\FM\24JAR2.SGM 24JAR2 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations for default fund contributions to QCCPs equals the sum of its capital requirement, KCM for each QCCP, as calculated under the methodology set KcM = max{KccP * ( Where: KCCP is the hypothetical capital requirement of the QCCP, as determined under paragraph (d)(5) of this section; DFpref is the prefunded default fund contribution of the clearing member FDIC-supervised institution to the QCCP; DFCCP is the QCCP’s own prefunded amounts that are contributed to the default waterfall and are junior or pari passu with prefunded default fund contributions of clearing members of the CCP; and DFCMpref is the total prefunded default fund contributions from clearing members of the QCCP to the QCCP. (5) Hypothetical capital requirement of a QCCP. Where a QCCP has provided its KCCP, a FDIC-supervised institution must rely on such disclosed figure instead of calculating KCCP under this paragraph (d)(5), unless the FDICsupervised institution determines that a more conservative figure is appropriate based on the nature, structure, or characteristics of the QCCP. The hypothetical capital requirement of a QCCP (KCCP), as determined by the FDIC-supervised institution, is equal to: KCCP = SCMi EADi * 1.6 percent Where: CMi is each clearing member of the QCCP; and EADi is the exposure amount of each clearing member of the QCCP to the QCCP, as determined under paragraph (d)(6) of this section. lotter on DSKBCFDHB2PROD with RULES2 (6) EAD of a clearing member FDICsupervised institution to a QCCP. (i) The EAD of a clearing member FDICsupervised institution to a QCCP is equal to the sum of the EAD for derivative contracts determined under paragraph (d)(6)(ii) of this section and the EAD for repo-style transactions determined under paragraph (d)(6)(iii) of this section. (ii) With respect to any derivative contracts between the FDIC-supervised institution and the CCP that are cleared transactions and any guarantees that the FDIC-supervised institution has VerDate Sep<11>2014 17:27 Jan 23, 2020 forth in paragraph (d)(4) of this section, multiplied by 12.5. (4) Capital requirement for default fund contributions to a QCCP. A Jkt 250001 DFpref pref ) ; D F CCP + D FCCPCM 0.16 percent* DFpref} provided to the CCP with respect to performance of a clearing member client on a derivative contract, the EAD is equal to the exposure amount for all such derivative contracts and guarantees of derivative contracts calculated under SA–CCR in § 324.132(c) (or, with respect to a CCP located outside the United States, under a substantially identical methodology in effect in the jurisdiction) using a value of 10 business days for purposes of § 324.132(c)(9)(iv); less the value of all collateral held by the CCP posted by the clearing member FDIC-supervised institution or a clearing member client of the FDIC-supervised institution in connection with a derivative contract for which the FDIC-supervised institution has provided a guarantee to the CCP and the amount of the prefunded default fund contribution of the FDIC-supervised institution to the CCP. (iii) With respect to any repo-style transactions between the FDICsupervised institution and the CCP that are cleared transactions, EAD is equal to: EAD = max{EBRM ¥ IM ¥ DF; 0} Where: EBRM is the sum of the exposure amounts of each repo-style transaction between the FDIC-supervised institution and the CCP as determined under § 324.132(b)(2) and without recognition of any collateral securing the repo-style transactions; IM is the initial margin collateral posted by the FDIC-supervised institution to the CCP with respect to the repo-style transactions; and DF is the prefunded default fund contribution of the FDIC-supervised institution to the CCP that is not already deducted in paragraph (d)(6)(ii) of this section. (iv) EAD must be calculated separately for each clearing member’s sub-client accounts and sub-house account (i.e., for the clearing member’s proprietary activities). If the clearing member’s collateral and its client’s PO 00000 Frm 00082 Fmt 4701 Sfmt 4702 clearing member FDIC-supervised institution’s capital requirement for its default fund contribution to a QCCP (KCM) is equal to: collateral are held in the same default fund contribution account, then the EAD of that account is the sum of the EAD for the client-related transactions within the account and the EAD of the house-related transactions within the account. For purposes of determining such EADs, the independent collateral of the clearing member and its client must be allocated in proportion to the respective total amount of independent collateral posted by the clearing member to the QCCP. (v) If any account or sub-account contains both derivative contracts and repo-style transactions, the EAD of that account is the sum of the EAD for the derivative contracts within the account and the EAD of the repo-style transactions within the account. If independent collateral is held for an account containing both derivative contracts and repo-style transactions, then such collateral must be allocated to the derivative contracts and repo-style transactions in proportion to the respective product specific exposure amounts, calculated, excluding the effects of collateral, according to § 324.132(b) for repo-style transactions and to § 324.132(c)(5) for derivative contracts. (vi) Notwithstanding any other provision of paragraph (d) of this section, with the prior approval of the FDIC, a FDIC-supervised institution may determine the risk-weighted asset amount for a default fund contribution to a QCCP according to § 324.35(d)(3)(ii). 36. Section 324.173 is amended in Table 13 to § 324.173 by revising line 4 under Part 2, Derivative exposures, to read as follows: ■ § 324.173 Disclosures by certain advanced approaches FDIC-supervised institutions and Category III FDIC-supervised institutions. * E:\FR\FM\24JAR2.SGM * * 24JAR2 * * ER24JA20.047</GPH> 4442 4443 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations TABLE 13 TO § 324.173—SUPPLEMENTARY LEVERAGE RATIO Dollar amounts in thousands Tril * * * * Bil Mil Thou * * * * * * * * * * Part 2: Supplementary leverage ratio * * * * Derivative exposures * * * * 4 Current exposure for derivative exposures (that is, net of cash variation margin). * * * 37. Section 324.300 is amended by adding paragraphs (g) and (h) to read as follows: ■ § 324.300 Transitions. * * * * * (g) SA–CCR. An advanced approaches FDIC-supervised institution may use CEM rather than SA–CCR for purposes of §§ 324.34(a) and 324.132(c) until January 1, 2022. A FDIC-supervised institution must provide prior notice to the FDIC if it decides to begin using SA– CCR before January 1, 2022. On January 1, 2022, and thereafter, an advanced approaches FDIC-supervised institution must use SA–CCR for purposes of §§ 324.34(a), 324.132(c), and 324.133(d). Once an advanced approaches FDICsupervised institution has begun to use * * SA–CCR, the advanced approaches FDIC-supervised institution may not change to use CEM. (h) Default fund contributions. Prior to January 1, 2022, a FDIC-supervised institution that calculates the exposure amounts of its derivative contracts under the standardized approach for counterparty credit risk in § 324.132(c) may calculate the risk-weighted asset amount for a default fund contribution to a QCCP under either method 1 under § 324.35(d)(3)(i) or method 2 under § 324.35(d)(3)(ii), rather than under § 324.133(d). Authority: 12 U.S.C. 1441, 1813, 1815, 1817–19, 1821. PART 327—ASSESSMENTS VI. Description of Scorecard Measures 39. Appendix A to subpart A of part 327 is amended in section VI by revising the entries ‘‘(2) Top 20 Counterparty Exposure/Tier 1 Capital and Reserves’’ and ‘‘(3) Largest Counterparty Exposure/ Tier 1 Capital and Reserves’’ to read as follows: ■ Appendix A to Subpart A of Part 327— Method To Derive Pricing Multipliers and Uniform Amount * * * * * 38. The authority citation for part 327 continues to read as follows: ■ Scorecard measures 1 Description lotter on DSKBCFDHB2PROD with RULES2 * * * * * * * (2) Top 20 Counterparty ExSum of the 20 largest total exposure amounts to counterparties divided by Tier 1 capital and reserves. The total posure/Tier 1 Capital and exposure amount is equal to the sum of the institution’s exposure amounts to one counterparty (or borrower) Reserves. for derivatives, securities financing transactions (SFTs), and cleared transactions, and its gross lending exposure (including all unfunded commitments) to that counterparty (or borrower). A counterparty includes an entity’s own affiliates. Exposures to entities that are affiliates of each other are treated as exposures to one counterparty (or borrower). Counterparty exposure excludes all counterparty exposure to the U.S. Government and departments or agencies of the U.S. Government that is unconditionally guaranteed by the full faith and credit of the United States. The exposure amount for derivatives, including OTC derivatives, cleared transactions that are derivative contracts, and netting sets of derivative contracts, must be calculated using the methodology set forth in 12 CFR 324.34(b), but without any reduction for collateral other than cash collateral that is all or part of variation margin and that satisfies the requirements of 12 CFR 324.10(c)(4)(ii)(C)(1)(ii) and (iii) and 324.10(c)(4)(ii)(C)(3) through (7). The exposure amount associated with SFTs, including cleared transactions that are SFTs, must be calculated using the standardized approach set forth in 12 CFR 324.37(b) or (c). For both derivatives and SFT exposures, the exposure amount to central counterparties must also include the default fund contribution.2 VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 PO 00000 Frm 00083 Fmt 4701 Sfmt 4702 E:\FR\FM\24JAR2.SGM 24JAR2 4444 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations Scorecard measures 1 Description (3) Largest Counterparty Exposure/Tier 1 Capital and Reserves. The largest total exposure amount to one counterparty divided by Tier 1 capital and reserves. The total exposure amount is equal to the sum of the institution’s exposure amounts to one counterparty (or borrower) for derivatives, SFTs, and cleared transactions, and its gross lending exposure (including all unfunded commitments) to that counterparty (or borrower). A counterparty includes an entity’s own affiliates. Exposures to entities that are affiliates of each other are treated as exposures to one counterparty (or borrower). Counterparty exposure excludes all counterparty exposure to the U.S. Government and departments or agencies of the U.S. Government that is unconditionally guaranteed by the full faith and credit of the United States. The exposure amount for derivatives, including OTC derivatives, cleared transactions that are derivative contracts, and netting sets of derivative contracts, must be calculated using the methodology set forth in 12 CFR 324.34(b), but without any reduction for collateral other than cash collateral that is all or part of variation margin and that satisfies the requirements of 12 CFR 324.10(c)(4)(ii)(C)(1)(ii) and (iii) and 324.10(c)(4)(ii)(C)(3) through (7). The exposure amount associated with SFTs, including cleared transactions that are SFTs, must be calculated using the standardized approach set forth in 12 CFR 324.37(b) or (c). For both derivatives and SFT exposures, the exposure amount to central counterparties must also include the default fund contribution.2 * * * * * * * 1 The FDIC retains the flexibility, as part of the risk-based assessment system, without the necessity of additional notice-and-comment rulemaking, to update the minimum and maximum cutoff values for all measures used in the scorecard. The FDIC may update the minimum and maximum cutoff values for the higher-risk assets to Tier 1 capital and reserves ratio in order to maintain an approximately similar distribution of higher-risk assets to Tier 1 capital and reserves ratio scores as reported prior to April 1, 2013, or to avoid changing the overall amount of assessment revenue collected. 76 FR 10672, 10700 (February 25, 2011). The FDIC will review changes in the distribution of the higher-risk assets to Tier 1 capital and reserves ratio scores and the resulting effect on total assessments and risk differentiation between banks when determining changes to the cutoffs. The FDIC may update the cutoff values for the higher-risk assets to Tier 1 capital and reserves ratio more frequently than annually. The FDIC will provide banks with a minimum one quarter advance notice of changes in the cutoff values for the higher-risk assets to Tier 1 capital and reserves ratio with their quarterly deposit insurance invoice. 2 EAD and SFTs are defined and described in the compilation issued by the Basel Committee on Banking Supervision in its June 2006 document, ‘‘International Convergence of Capital Measurement and Capital Standards.’’ The definitions are described in detail in Annex 4 of the document. Any updates to the Basel II capital treatment of counterparty credit risk would be implemented as they are adopted. http://www.bis.org/ publ/bcbs128.pdf. * * * * * lotter on DSKBCFDHB2PROD with RULES2 Dated: November 18, 2019. Morris R. Morgan, First Deputy Comptroller, Comptroller of the Currency. VerDate Sep<11>2014 17:27 Jan 23, 2020 Jkt 250001 By order of the Board of Governors of the Federal Reserve System, November 19, 2019. Ann E. Misback, Secretary of the Board. Dated at Washington, DC, on November 19, 2019. Annmarie H. Boyd, Assistant Executive Secretary. Federal Deposit Insurance Corporation. By order of the Board of Directors. [FR Doc. 2019–27249 Filed 1–23–20; 8:45 am] PO 00000 Frm 00084 Fmt 4701 Sfmt 9990 BILLING CODE 4810–33–P E:\FR\FM\24JAR2.SGM 24JAR2

Agencies

[Federal Register Volume 85, Number 16 (Friday, January 24, 2020)]
[Rules and Regulations]
[Pages 4362-4444]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-27249]



[[Page 4361]]

Vol. 85

Friday,

No. 16

January 24, 2020

Part II





Department of the Treasury





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Office of the Comptroller of the Currency





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12 CFR Parts 3 and 32





Federal Reserve System





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12 CFR Part 217





Federal Deposit Insurance Corporation





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12 CFR Parts 324 and 327





Standardized Approach for Calculating the Exposure Amount of Derivative 
Contracts; Final Rule

Federal Register / Vol. 85 , No. 16 / Friday, January 24, 2020 / 
Rules and Regulations

[[Page 4362]]


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DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency

12 CFR Parts 3 and 32

[Docket ID OCC-2018-0030]
RIN 1557-AE44

FEDERAL RESERVE SYSTEM

12 CFR Part 217

[Docket No. R-1629]
RIN 7100-AF22

FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Parts 324 and 327

RIN 3064-AE80


Standardized Approach for Calculating the Exposure Amount of 
Derivative Contracts

AGENCY: The Office of the Comptroller of the Currency, Treasury; the 
Board of Governors of the Federal Reserve System; and the Federal 
Deposit Insurance Corporation.

ACTION: Final rule.

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SUMMARY: The Office of the Comptroller of the Currency, the Board of 
Governors of the Federal Reserve System, and the Federal Deposit 
Insurance Corporation are issuing a final rule to implement a new 
approach--the standardized approach for counterparty credit risk (SA-
CCR)--for calculating the exposure amount of derivative contracts under 
these agencies' regulatory capital rule. Under the final rule, an 
advanced approaches banking organization may use SA-CCR or the internal 
models methodology to calculate its advanced approaches total risk-
weighted assets, and must use SA-CCR, instead of the current exposure 
methodology, to calculate its standardized total risk-weighted assets. 
A non-advanced approaches banking organization may use the current 
exposure methodology or SA-CCR to calculate its standardized total 
risk-weighted assets. The final rule also implements SA-CCR in other 
aspects of the capital rule. Notably, the final rule requires an 
advanced approaches banking organization to use SA-CCR to determine the 
exposure amount of derivative contracts included in the banking 
organization's total leverage exposure, the denominator of the 
supplementary leverage ratio. In addition, the final rule incorporates 
SA-CCR into the cleared transactions framework and makes other 
amendments, generally with respect to cleared transactions.

DATES: Effective date: April 1, 2020. Mandatory compliance date: 
January 1, 2022, for advanced approaches banking organizations.

FOR FURTHER INFORMATION CONTACT: 
    OCC: Margot Schwadron, Director or Guowei Zhang, Risk Expert, 
Capital Policy, (202) 649-7106; Kevin Korzeniewski, Counsel, or Ron 
Shimabukuro, Senior Counsel, Chief Counsel's Office, (202) 649-5490; 
or, for persons who are deaf or hearing impaired, TTY, (202) 649-5597.
    Board: Constance M. Horsley, Deputy Associate Director, (202) 452-
5239; David Lynch, Deputy Associate Director, (202) 452-2081; Elizabeth 
MacDonald, Manager, (202) 475-6316; Michael Pykhtin, Manager, (202) 
912-4312; Mark Handzlik, Lead Financial Institutions Policy Analyst, 
(202) 475-6636; Sara Saab, Senior Financial Institutions Policy Analyst 
II, (202) 872-4936; or Cecily Boggs, Senior Financial Institutions 
Policy Analyst II, (202) 530-6209; Division of Supervision and 
Regulation; or Mark Buresh, Senior Counsel, (202) 452-5270; Gillian 
Burgess, Senior Counsel (202) 736-5564; or Andrew Hartlage, Counsel, 
(202) 452-6483; Legal Division, Board of Governors of the Federal 
Reserve System, 20th and C Streets NW, Washington, DC 20551. For the 
hearing impaired only, Telecommunication Device for the Deaf, (202) 
263-4869.
    FDIC: Bobby R. Bean, Associate Director, [email protected]; Irina 
Leonova, Senior Policy Analyst, [email protected]; Peter Yen, Senior 
Policy Analyst, [email protected], Capital Markets Branch, Division of Risk 
Management Supervision, (202) 898-6888; or Michael Phillips, Counsel, 
[email protected]; Catherine Wood, Counsel, [email protected]; 
Supervision Branch, Legal Division, Federal Deposit Insurance 
Corporation, 550 17th Street NW, Washington, DC 20429.

SUPPLEMENTARY INFORMATION: 

Table of Contents

I. Introduction and Overview of the Proposal
    A. Overview of Derivative Contracts
    B. The Basel Committee Standard on SA-CCR
    C. Overview of the Proposal
II. Overview of the Final Rule
    A. Scope and Application of the Final Rule
    B. Effective Date and Compliance Deadline
    C. Final Rule's Interaction With Agency Requirements and Other 
Proposals
III. Mechanics of the Standardized Approach for Counterparty Credit 
Risk
    A. Exposure Amount
    B. Definition of Netting Sets and Treatment of Financial 
Collateral
    C. Replacement Cost
    D. Potential Future Exposure
IV. Revisions to the Cleared Transactions Framework
    A. Trade Exposure Amount
    B. Treatment of Default Fund Contributions
V. Revisions to the Supplementary Leverage Ratio
VI. Technical Amendments
    A. Receivables Due From a QCCP
    B. Treatment of Client Financial Collateral Held by a CCP
    C. Clearing Member Exposure When CCP Performance Is Not 
Guaranteed
    D. Bankruptcy Remoteness of Collateral
    E. Adjusted Collateral Haircuts for Derivative Contracts
    F. OCC Revisions to Lending Limits
    G. Other Clarifications and Technical Amendments From the 
Proposal to the Final Rule
VII. Impact of the Final Rule
VIII. Regulatory Analyses
    A. Paperwork Reduction Act
    B. Regulatory Flexibility Act
    C. Plain Language
    D. Riegle Community Development and Regulatory Improvement Act 
of 1994
    E. OCC Unfunded Mandates Reform Act of 1995 Determination
    F. The Congressional Review Act

I. Introduction and Overview of the Proposal

A. Overview of Derivative Contracts

    In general, derivative contracts represent agreements between 
parties either to make or receive payments or to buy or sell an 
underlying asset on a certain date (or dates) in the future. Parties 
generally use derivative contracts to mitigate risk, although such 
transactions may serve other purposes. For example, an interest rate 
derivative contract allows a party to manage the risk associated with a 
change in interest rates, while a commodity derivative contract allows 
a party to fix commodity prices in the future and thereby minimize any 
exposure attributable to unfavorable movements in those prices.
    The value of a derivative contract, and thus a party's exposure to 
its counterparty, changes over the life of the contract based on 
movements in the value of the reference rates, assets, indicators or 
indices underlying the contract (reference exposures). A party with a 
positive current exposure expects to receive a payment or other 
beneficial transfer from the counterparty and is considered to be ``in 
the money.'' A party that is in the money is subject to the risk that 
the counterparty will default on its obligations and fail to pay the 
amount owed under the transaction, which is referred to as counterparty 
credit risk. In contrast, a party with a zero or negative current 
exposure does not expect to receive a payment or beneficial transfer 
from the counterparty

[[Page 4363]]

and is considered to be ``at the money'' or ``out of the money.'' A 
party that has no current exposure to counterparty credit risk may have 
exposure to counterparty credit risk in the future if the derivative 
contract becomes ``in the money.''
    Parties to a derivative contract often exchange collateral to 
mitigate counterparty credit risk. If a counterparty defaults, the non-
defaulting party can sell the collateral to offset its exposure. In the 
derivatives context, collateral may include variation margin and 
initial margin (also known as independent collateral). Parties exchange 
variation margin on a periodic basis during the term of a derivative 
contract, as typically specified in a variation margin agreement or by 
regulation.\1\ Variation margin offsets changes in the market value of 
a derivative contract and thereby covers the potential loss arising 
from the default of a counterparty. Variation margin may not always be 
sufficient to cover a party's positive exposure (e.g., due to delays in 
receiving collateral), and thus parties may exchange initial margin. 
Parties typically exchange initial margin at the outset of the 
derivative contract and in amounts that are expected to reduce the 
likelihood of a positive exposure amount for the derivative contract in 
the event of the counterparty's default, resulting in 
overcollateralization.
---------------------------------------------------------------------------

    \1\ See, e.g., 12 CFR part 45 (OCC); 12 CFR part 237 (Board); 
and 12 CFR part 349 (FDIC).
---------------------------------------------------------------------------

    To facilitate the exchange of collateral, parties may enter into 
variation margin agreements that typically provide for a threshold 
amount and a minimum transfer amount. The threshold amount is the 
maximum amount by which the market value of the derivative contract can 
change before a party must collect or post variation margin (in other 
words, the threshold amount specifies an acceptable amount of under-
collateralization). The minimum transfer amount is the smallest amount 
of collateral that a party must transfer when it is required to 
exchange collateral under the variation margin agreement. Parties 
generally apply a discount (also known as a haircut) to non-cash 
collateral to account for a potential reduction in the value of the 
collateral during the period between the last exchange of collateral 
before the close out of the derivative contract (as in the case of 
default of the counterparty) and replacement of the contract on the 
market. This period is known as the margin period of risk (MPOR).
    Two parties often will enter into a large number of derivative 
contracts together. In such cases, the parties may enter into a netting 
agreement to allow for the offsetting of the derivative contracts under 
the agreement in the event that one of the parties default and to 
streamline certain aspects of the transactions, including the exchange 
of collateral. Netting multiple contracts against each other can 
substantially reduce the exposure if one of the parties were to 
default. A netting set reflects those derivative contracts that are 
subject to the same master netting agreement.\2\
---------------------------------------------------------------------------

    \2\ ``Qualifying master netting agreement'' is defined in 
Sec. Sec.  _.2 and _.3(d) of the capital rule. See 12 CFR 3.2 and 
3.3(d) (OCC); 12 CFR 217.2 and 217.3(d) (Board); and 12 CFR 324.2 
and 324.3(d) (FDIC).
---------------------------------------------------------------------------

    Parties to a derivative contract may also clear their derivative 
contract through a central counterparty (CCP). The use of central 
clearing is designed to reduce the risk of engaging in derivative 
transactions through the multilateral netting of exposures, 
establishment and enforcement of collateral requirements, and the 
promotion of market transparency. A party engages with a CCP either as 
a clearing member or as a clearing member client. A clearing member is 
a member of, or a direct participant in, a CCP that has authority to 
enter into transactions with the CCP. A clearing member may act as a 
financial intermediary with respect to the clearing member client and 
either take one position with the client and an offsetting position 
with the CCP (the principal model of clearing) or guarantee the 
performance of the clearing member client to the CCP (the agency model 
of clearing). With respect to the latter type of clearing, the clearing 
member generally is responsible for fulfilling initial and variation 
margin calls from the CCP on behalf of its client, irrespective of the 
client's ability to post such collateral.
    The capital rule of the Office of the Comptroller of the Currency 
(OCC), the Board of Governors of the Federal Reserve System (Board), 
and the Federal Deposit Insurance Corporation (FDIC) (together, the 
agencies) requires a banking organization to hold regulatory capital 
based on the exposure amount of its derivative contracts.\3\ The 
capital rule prescribes different approaches for measuring the exposure 
amount of derivative contracts based on the size and risk profile of a 
banking organization. All banking organizations are currently required 
to use the current exposure method (CEM) to determine the exposure 
amount of a derivative contract for purposes of calculating 
standardized total risk-weighted assets.\4\ Certain large banking 
organizations may use CEM or the internal models methodology (IMM) to 
determine the exposure amount of a derivative contract for advanced 
approaches risk-weighted assets. In contrast to CEM, IMM is an 
internal-models-based approach that requires supervisory approval. The 
capital rule also requires certain large banking organizations to meet 
a supplementary leverage ratio, measured as the banking organization's 
tier 1 capital relative to its total leverage exposure.\5\ The total 
leverage exposure measure captures both on- and off-balance sheet 
assets, including the exposure amount of a banking organization's 
derivative contracts as determined under CEM.\6\
---------------------------------------------------------------------------

    \3\ 12 CFR part 3 (OCC); 12 CFR part 217 (Board); 12 CFR part 
324 (FDIC). The agencies have codified the capital rule in different 
parts of title 12 of the CFR, but the internal structure of the 
sections within each agency's rule are identical. All references to 
sections in the capital rule or the proposal are intended to refer 
to the corresponding sections in the capital rule of each agency. 
Banking organizations subject to the agencies' capital rule include 
national banks, state member banks, insured state nonmember banks, 
savings associations, and top-tier bank holding companies and 
savings and loan holding companies domiciled in the United States, 
but exclude banking organizations subject to the Board's Small Bank 
Holding Company and Savings and Loan Holding Company Policy 
Statement (12 CFR part 225, appendix C), and certain savings and 
loan holding companies that are substantially engaged in insurance 
underwriting or commercial activities or that are estate trusts, and 
bank holding companies and savings and loan holding companies that 
are employee stock ownership plans. The agencies recently adopted a 
final rule to implement a community bank leverage ratio framework 
that is applicable, on an optional basis to depository institutions 
and depository institution holding companies with less than $10 
billion in total consolidated assets and that meet certain other 
criteria. Such banking organizations that opt into the community 
bank leverage ratio framework will be deemed compliant with the 
capital rule's generally applicable requirements and are not 
required to calculate risk-based capital ratios. See 84 FR 61776 
(November 13, 2019).
    \4\ CEM and IMM are also applied in other parts of the capital 
rule. For example, advanced approaches banking organizations must 
use CEM to determine the exposure amount of derivative contracts 
included in total leverage exposure, the denominator of the 
supplementary leverage ratio. In addition, the capital rule 
incorporates CEM into the cleared transactions framework and makes 
other amendments, generally with respect to cleared transactions. 
See section II.C. of this SUPPLEMENTARY INFORMATION for further 
discussion.
    \5\ See infra note 23. Banking organizations subject to Category 
I, Category II, or Category III standards are subject to the 
supplementary leverage ratio.
    \6\ See 12 CFR 3.10(c)(4) (OCC); 12 CFR 217.10(c)(4) (Board); 
and 12 CFR 324.10(c)(4) (FDIC).

---------------------------------------------------------------------------

[[Page 4364]]

B. The Basel Committee Standard on SA-CCR

    In 2014, the Basel Committee on Banking Supervision released a new 
approach for calculating the exposure amount of a derivative contract 
called the standardized approach for counterparty credit risk (SA-CCR) 
(the Basel Committee standard).\7\ Under the Basel Committee standard, 
a banking organization calculates the exposure amount of its derivative 
contracts at the netting set level, meaning, those contracts that the 
standard permits to be netted against each other because they are 
subject to the same qualifying master netting agreement (QMNA), which 
must meet certain operational requirements.\8\ The exposure amount of a 
derivative contract not subject to a QMNA is calculated individually, 
and thus the derivative contract constitutes a netting set of one.
---------------------------------------------------------------------------

    \7\ See ``The standardized approach for measuring counterparty 
credit risk exposures,'' Basel Committee on Banking Supervision 
(March 2014, rev. April 2014), https://www.bis.org/publ/bcbs279.pdf.
    \8\ See e.g. supra note 2.
---------------------------------------------------------------------------

    The exposure amount of each netting set is equal to an alpha factor 
of 1.4 multiplied by the sum of the replacement cost of the netting set 
and the potential future exposure (PFE) of the netting set:

exposure amount = 1.4 * (replacement cost + PFE)

    For netting sets that are not subject to a variation margin 
agreement, replacement cost reflects a banking organization's current 
on-balance-sheet credit exposure to its counterparty measured as the 
maximum of the fair value of the derivative contracts within the 
netting set less the applicable collateral or zero. For netting sets 
that are subject to a variation margin agreement, the replacement cost 
of a netting set reflects the maximum possible unsecured exposure 
amount of the netting set that would not trigger a variation margin 
call. For the replacement cost calculation, a banking organization 
recognizes the collateral amount on a dollar-for-dollar basis, subject 
to any applicable haircuts.
    PFE reflects a measure of potential changes in a banking 
organization's counterparty exposure for a netting set over a specified 
period. The PFE calculation allows a banking organization to fully or 
partially offset derivative contracts within the same netting set that 
share similar risk factors, based on the concept of hedging sets. Under 
the Basel Committee standard, derivative contracts form a hedging set 
if they share the same primary risk factor, and therefore, are within 
the same asset class--interest rate, exchange rate, credit, equity, or 
commodities. As derivatives within the same asset class are highly 
correlated and thus have an economic relationship,\9\ under the Basel 
Committee standard, derivative contracts within the same hedging set 
may be able to fully or partially offset each other.
---------------------------------------------------------------------------

    \9\ Derivative contracts within the same asset class share the 
same primary risk factor, which implies a closer alignment between 
all of the underlying risk factors and a higher correlation factor. 
For a directional portfolio, greater alignment between the risk 
factors would result in a more concentrated risk, leading to a 
higher exposure amount. For a balanced portfolio, greater alignment 
between the risk factors would result in more offsetting of risk, 
leading to a lower exposure amount.
---------------------------------------------------------------------------

    To obtain the PFE for each netting set, a banking organization sums 
the adjusted derivative contract amount of all hedging sets within the 
netting set using an asset-class specific aggregation formula and 
multiples that amount by the PFE multiplier. The PFE multiplier 
decreases exponentially from a value of one as the value of the 
financial collateral held by the banking organization exceeds the net 
fair value of the derivative contracts within the netting set, subject 
to a floor of five percent. Thus, the PFE multiplier accounts for both 
over-collateralization and the negative fair value amount of the 
derivative contracts within the netting set.
    For purposes of calculating the hedging set amount, a banking 
organization calculates the adjusted notional amount of a derivative 
contract and multiplies that amount by a corresponding supervisory 
factor, maturity factor, and supervisory delta to determine a 
conservative estimate of effective expected positive exposure (EEPE), 
assuming zero fair value and zero collateral.\10\ The Basel Committee 
standard uses supervisory factors that reflect the volatilities 
observed in the derivatives markets during the financial crisis. The 
supervisory factors reflect the potential variability of the primary 
risk factor of the derivative contract over a one-year horizon. The 
maturity factor scales down the default one-year risk horizon of the 
supervisory factor to the risk horizon appropriate for the derivative 
contract. For the supervisory delta adjustment, a banking organization 
applies a positive sign to the derivative contract amount if the 
derivative contract is long the risk factor and a negative sign if the 
derivative contract is short the risk factor. A derivative contract is 
long the primary risk factor if the fair value of the instrument 
increases when the value of the primary risk factor increases. A 
derivative contract is short the primary risk factor if the fair value 
of the instrument decreases when the value of the primary risk factor 
increases. The assumptions of zero fair value and zero collateral allow 
for recognition of offsetting and diversification benefits between 
derivative contracts that share similar risk factors (i.e., long and 
short derivative contracts within the same hedging set could fully or 
partially offset one another).
---------------------------------------------------------------------------

    \10\ Under IMM, an advanced approaches banking organization uses 
its own internal models to determine the exposure amount of its 
derivative contracts. The exposure amount under IMM is calculated as 
the product of the EEPE for a netting set, which is the time-
weighted average of the effective expected exposures (EE) profile 
over a one-year horizon, and an alpha factor. For the purposes of 
regulatory capital calculations, the resulting exposure amount is 
treated as a loan equivalent exposure, which is the amount 
effectively loaned by the banking organization to the counterparty 
under the derivative contract. A banking organization arrives at the 
exposure amount by first determining the EE profile for each netting 
set. In general, EE profile is determined by computing exposure 
distributions over a set of future dates using Monte Carlo 
simulations, and the expectation of exposure at each date is the 
simple average of all positive Monte Carlo simulated exposures for 
each date. The expiration of short-term trades can cause the EE 
profile to decrease, even though a banking organization is likely to 
replace short-term trades with new trades (i.e., rollover). To 
account for rollover, a banking organization converts the EE profile 
for each netting set into an effective EE profile by applying a 
nondecreasing constraint to the corresponding EE profile over the 
first year. The nondecreasing constraint prevents the effective EE 
profile from declining with time by replacing the EE amount at a 
given future date with the maximum of the EE amounts across this and 
all prior simulation dates. The EEPE for a netting set is the time-
weighted average of the effective EE profile over a one-year 
horizon. EEPE would be the appropriate loan equivalent exposure in a 
credit risk capital calculation if the following assumptions were 
true: There is no concentration risk, systematic market risk, and 
wrong-way risk (i.e., the size of an exposure is positively 
correlated with the counterparty's probability of default). However, 
these conditions nearly never exist with respect to a derivative 
contract. Thus, to account for these risks, IMM requires a banking 
organization to multiply EEPE by 1.4.
---------------------------------------------------------------------------

C. Overview of the Proposal

    On October 30, 2018, the agencies published a notice of proposed 
rulemaking (proposal) to implement SA-CCR \11\ in order to provide 
important improvements to risk sensitivity and calibration relative to 
CEM.\12\ In particular, the implementation of SA-CCR is responsive to 
concerns that CEM has not kept pace with certain market practices that 
have been adopted, particularly by large banking organizations that are

[[Page 4365]]

active in the derivatives market.\13\ The agencies also proposed SA-CCR 
to provide a method that is less complex and involves less discretion 
than IMM, which allows banking organizations to use their own internal 
models to determine the exposure amount of their derivative 
contracts.\14\ Although IMM is more risk-sensitive than CEM, IMM is 
significantly more complex and requires prior supervisory approval.\15\ 
The agencies based the core elements of the proposal on the Basel 
Committee SA-CCR standard.\16\
---------------------------------------------------------------------------

    \11\ See 83 FR 64660 (December 17, 2018).
    \12\ The Supplementary Information set forth in the proposal 
includes a description of CEM. See id. at 64664.
    \13\ The agencies initially adopted CEM in 1989. See 54 FR 4168 
(January 27, 1989) (Board and OCC); 54 FR 11500 (March 21, 1989) 
(FDIC). The last significant update to CEM was in 1995. See 60 FR 
46170 (September 5, 1995).
    \14\ The Supplementary Information set forth in the proposal 
includes a description of IMM. See 83 FR at 64665.
    \15\ See 12 CFR 3.122 (OCC); 12 CFR 217.122 (Board); and 12 CFR 
324.122 (FDIC).
    \16\ See supra note 7.
---------------------------------------------------------------------------

    The agencies received approximately 58 comments on the proposal 
from interested parties, including banking organizations, trade groups, 
members of Congress, and advocacy organizations. Banking organizations 
and trade groups offered widespread support for the implementation of 
SA-CCR although they also suggested modifications to various components 
of the proposal largely to address concerns regarding its calibration. 
Commenters who supported the proposal also expressed concerns with its 
proposed implementation schedule and potential interaction with certain 
other U.S. laws and regulations. Other commenters, including some 
commercial entities that use derivative contracts to manage risks 
arising from their business operations (commercial end-users), opposed 
the proposal or elements of the proposal. Specifically, these 
commenters expressed concern that the proposal could indirectly 
increase the fees they pay to enter into derivative transactions to 
manage commercial risks in order to help offset the regulatory capital 
costs of such derivative contracts for banking organizations. The 
commenters asserted that any such effect would be in contravention of 
separate public policy objectives designed to support the ability of 
commercial end-users to engage in derivative transactions for risk-
management purposes.\17\ By contrast, other commenters that opposed the 
proposal expressed concerns that it could reduce capital held against 
derivative contracts.
---------------------------------------------------------------------------

    \17\ See, e.g., The Commodity Exchange Act and the Securities 
Exchange Act of 1934, as amended by sections 731 and 764, 
respectively, of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act, Public Law 111-203, 124 Stat. 1376, 1703-12, 1784-96 
(2010), require the agencies to, in establishing capital and margin 
requirements for non-cleared swaps, provide an exemption for certain 
types of counterparties (e.g., counterparties that are not financial 
entities and are using swaps to hedge or mitigate commercial risks) 
from the mandatory clearing requirement. See 7 U.S.C. 6s(e)(3)(C); 
15 U.S.C. 78o-10(e)(3)(C); see also 12 CFR part 45 (OCC); 12 CFR 
part 237 (Board); and 12 CFR part 349 (FDIC) (swap margin rule).
---------------------------------------------------------------------------

    As discussed in detail below, the agencies are finalizing the 
proposal with some modifications to address certain concerns raised by 
commenters. In particular, the final rule removes the alpha factor of 
1.4 from the exposure amount calculation for derivative contracts with 
commercial end-user counterparties. This change will reduce the 
exposure amount of such derivative contracts by roughly 29 percent, in 
comparison to similar derivative contracts with a counterparty that is 
not a commercial end-user.
    Commenters also raised concerns regarding the proposed netting 
treatment for settled-to-market derivative contracts.\18\ The final 
rule allows a banking organization to elect, at the netting set level, 
to treat all such contracts within the same netting set as 
collateralized-to-market, thus allowing netting of settled-to-market 
derivative contracts with collateralized-to-market derivative contracts 
within the same netting set. In order to make the election, a banking 
organization must treat the settled-to-market derivative contracts as 
collateralized-to-market derivative contracts for all purposes under 
the SA-CCR calculation, including by applying the MPOR treatment 
applicable to collateralized-to-market derivative transactions.\19\
---------------------------------------------------------------------------

    \18\ Settled-to-market derivatives contracts are those entered 
into between a central counterparty and a banking organization, 
under which the central counterparty's rulebook considers daily 
payments of variation margin as a settlement payment for the 
exposure that arises from marking the derivative contract to fair 
value. These payments are similar to traditional exchanges of 
variation margin, except that the receiving party takes title to the 
payment from the transferring party rather than holding the assets 
as collateral, and thus effectively settles the contract.
    \19\ Banking organizations that make such an election would 
apply the maturity factor applicable to margined transactions under 
the final rule. See also section III.D.4. of this Supplementary 
Information.
---------------------------------------------------------------------------

    Commenters also criticized the proposal's approach to the 
recognition of collateral provided to support a derivative contract for 
purposes of the supplementary leverage ratio. In response to 
commenters' concerns, and consistent with changes to the Basel 
Committee leverage ratio standard that occurred during the comment 
period, the final rule allows for greater recognition of collateral in 
the calculation of total leverage exposure relating to client-cleared 
derivative contracts.\20\
---------------------------------------------------------------------------

    \20\ See ``Leverage ratio treatment of client cleared 
derivatives,'' Basel Committee on Banking Supervision, June 2019, 
https://www.bis.org/bcbs/publ/d467.pdf. See also section V of this 
Supplementary Information.
---------------------------------------------------------------------------

II. Overview of the Final Rule

    Figure 1 below provides a high-level overview of SA-CCR under the 
Final Rule.
---------------------------------------------------------------------------

    \21\ A counterparty's maximum exposure to a netting set subject 
to a varation margin agreement equals the threshold amount plus 
minimum transfer amount.
    \22\ Net independent collateral amount (NICA), as described in 
section III. B of this Supplementary Information.

            Figure 1--Overview of SA-CCR Under the Final Rule
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Purpose...........................   The final rule implements
                                     the standardized approach for
                                     counterparty-credit risk, in a
                                     manner consistent with the core
                                     elements of the Basel Committee
                                     standard.
                                     A banking organization uses
                                     SA-CCR (either on a mandatory or an
                                     optional basis) to determine the
                                     capital requirements for its
                                     derivative contracts.
SA-CCR Mechanics..................  Under the final rule, a banking
                                     organization using SA-CCR
                                     determines the exposure amount for
                                     a netting set of derivative
                                     contracts as follows:
                                      Exposure amount = alpha factor x
                                        (replacement cost + potential
                                               future exposure)
------------------------------------------------------------------------
                   Key Elements of the SA-CCR Formula
------------------------------------------------------------------------
Replacement Cost..................  The replacement cost of a derivative
                                     contract reflects the amount that
                                     it would cost a banking
                                     organization to replace the
                                     derivative contract if the
                                     counterparty were to immediately
                                     default. Under SA-CCR, replacement
                                     cost is based on the fair value of
                                     a derivative contract under U.S.
                                     GAAP, with adjustments to reflect
                                     the exchange of collateral for
                                     margined transactions.

[[Page 4366]]

 
                                    For un-margined transactions: RC =
                                     max{V - C; 0{time} , where
                                     replacement cost (RC) equals the
                                     maximum of the fair value of the
                                     derivative contract (after
                                     excluding any valuation
                                     adjustments) (V) less the net
                                     amount of any collateral (C)
                                     received from the counterparty and
                                     zero.
                                    For margined transactions: RC =
                                     max{V - C; TH + MTA - NICA; 0{time}
                                     , where replacement cost equals the
                                     maximum of (1) the sum of the fair
                                     values (after excluding any
                                     valuation adjustments) of the
                                     derivative contracts within the
                                     netting set less the net amount of
                                     collateral applicable to such
                                     derivative contracts; (2) the
                                     counterparty's maximum exposure to
                                     the netting set under the variation
                                     margin agreement (TH + MTA),\21\
                                     less the net collateral amount
                                     applicable to such derivative
                                     contracts (NICA \22\); or (3) zero.
Potential Future Exposure.........  The potential future exposure of a
                                     derivative contract reflects the
                                     possibility of changes in the value
                                     of the derivative contract over a
                                     specified period. Under SA-CCR, the
                                     potential future exposure amount is
                                     based on the notional amount and
                                     maturity of the derivative
                                     contract, volatilities observed
                                     during the financial crisis for
                                     different classes of derivative
                                     contracts (i.e., interest rate,
                                     exchange rate, credit, equity, and
                                     commodity), the exchange of
                                     collateral, and full or partial
                                     offsetting among derivative
                                     contracts that share an economic
                                     relationship.
                                    PFE = multiplier x aggregated
                                     amount, where the PFE multiplier
                                     decreases exponentially from a
                                     value of 1 to recognize the amount
                                     of any excess collateral and the
                                     negative fair values of derivative
                                     contracts within the netting set.
                                     The aggregated amount accounts for
                                     full or partial offsetting among
                                     derivative contracts within a
                                     hedging set that share an economic
                                     relationship, as well as observed
                                     volatilities in the reference
                                     asset, the maturity of the
                                     derivative contract, and the
                                     correlation between the derivative
                                     contract and the reference exposure
                                     (i.e., long or short).
Alpha Factor......................  The alpha factor is a measure of
                                     conservatism that is designed to
                                     address risks that are not directly
                                     captured under SA-CCR, and to
                                     ensure that the capital requirement
                                     for a derivative contract under SA-
                                     CCR is generally not lower than the
                                     one produced under IMM.
                                    For most derivative contracts, the
                                     alpha factor equals 1.4; however,
                                     no alpha factor applies to
                                     derivative contracts with
                                     commercial end-user counterparties.
------------------------------------------------------------------------

A. Scope and Application of the Final Rule

1. Scoping Criteria
    The capital rule provides two methodologies for determining total 
risk-weighted assets: The standardized approach, which applies to all 
banking organizations, and the advanced approaches, which apply only to 
``advanced approaches banking organizations,'' (or banking 
organizations subject to Category I or Category II standards) \23\ as 
defined under the capital rule.\24\ Both the standardized approach and 
the advanced approaches require a banking organization to determine the 
exposure amount for derivative contracts transacted through a central 
counterparty (i.e., cleared transactions) and derivative contracts that 
are not cleared transactions (i.e., noncleared derivative contracts, 
otherwise known as over-the-counter derivative contracts).\25\ As part 
of the cleared transactions framework, a banking organization also must 
determine the risk-weighted asset amounts of any contributions or 
commitments it may have to mutualized loss sharing agreements with 
central counterparties (i.e., default fund contributions).\26\
---------------------------------------------------------------------------

    \23\ The agencies recently adopted a final rule to revise the 
criteria for determining the applicability of regulatory capital and 
liquidity requirements for large U.S. and foreign banking 
organizations (tailoring final rule). Under the tailoring final 
rule, an advanced approaches banking organization means a banking 
organization subject to Category I or Category II standards. 
Category I standards apply to U.S. global systemically important 
bank holding companies (U.S. GSIBs) and their depository institution 
subsidiaries, as identified based on the methodology in the Board's 
U.S. GSIB surcharge rule. Category II standards apply to banking 
organizations that are not subject to Category I standards and that 
have $700 billion or more in total consolidated assets or $75 
billion or more in cross-jurisdictional activity and to their 
depository institution subsidiaries. Category III standards apply to 
banking organizations that are not subject to Category I or II 
standards and that have $250 billion or more in total consolidated 
assets or $75 billion or more in any of nonbank assets, weighted 
short-term wholesale funding, or off-balance-sheet exposure. 
Category III standards also apply to depository institution 
subsidiaries of any holding company subject to Category III 
standards. Category IV standards apply to banking organizations with 
total consolidated assets of $100 billion or more, and their 
depositiory institution subsidiaries, that do not meet any of the 
criteria for a higher category of standards. See ``Changes to 
Applicabiltiy Thresholds for Regulatory Capital and Liquidity 
Requirements,'' 84 FR 59230 (November 1, 2019).
    \24\ Standardized total risk-weighted assets serve as a floor 
for advanced approaches total risk-weighted assets. Advanced 
approaches banking organizations must therefore calculate total 
risk-weighted assets under both approaches and use the result that 
produces a more binding capital requirement. Total risk-weighted 
assets are the denominator of the risk-based capital ratios; 
regulatory capital is the numerator.
    \25\ Under the standardized approach, the risk-weighted asset 
amount for a derivative contract currently is the product of the 
exposure amount of the derivative contract calculated under CEM and 
the risk weight for the type of counterparty as set forth in the 
capital rule. See generally 12 CFR 3.35 (OCC); 12 CFR 217.35 
(Board); and 12 CFR 324.35 (FDIC). Under the advanced approaches, 
the risk-weighted asset amount for a derivative contract currently 
is derived using either CEM or the internal models methodology, 
which multiplies the exposure amount (or exposure at default amount) 
of the derivative contract by a models-based formula that uses risk 
parameters determined by a banking organization's internal 
methodologies. See generally 12 CFR 3.132 (OCC); 12 CFR 217.132 
(Board); and 12 CFR 324.132 (FDIC).
    \26\ See 12 CFR 3.35(d) and 3.133(d) (OCC); 12 CFR 217.35(d) and 
217.133(d) (Board); and 12 CFR 324.35(d) and 324.133(d) (FDIC).
---------------------------------------------------------------------------

    The proposal would have replaced CEM with SA-CCR in the capital 
rule for advanced approaches banking organizations. Thus, for purposes 
of the advanced approaches, an advanced approaches banking organization 
would have been required to use either SA-CCR or IMM to calculate the 
exposure amount of its noncleared and cleared derivative contracts and 
to use SA-CCR to determine the risk-weighted asset amount of its 
default fund contributions. For purposes of the standardized approach, 
an advanced approaches banking organization would have been required to 
use SA-CCR (instead of CEM) to calculate the exposure amount of its 
noncleared and cleared derivative contracts and to determine the risk-
weighted asset amount of its default fund contributions. The proposal 
also would have revised the total leverage exposure measure of the 
supplementary leverage ratio by replacing CEM with a modified version 
of SA-CCR.
    Banking organizations that are not advanced approaches banking 
organizations \27\ would have had to choose either CEM or SA-CCR to 
calculate the exposure amount of

[[Page 4367]]

noncleared and cleared derivative contracts and to determine the risk-
weighted asset amount of default fund contributions under the 
standardized approach.
---------------------------------------------------------------------------

    \27\ Under this final rule, banking organizations that are not 
advanced approaches banking organizations (i.e., banking 
organizations subject to Category III or Category IV standards) are 
permitted to choose either CEM or SA-CCR for purposes of determining 
standardized risk-weighted assets. See supra note 23.
---------------------------------------------------------------------------

    Some commenters raised concerns with the proposal's use of multiple 
methods--CEM, SA-CCR, and IMM--to determine the exposure amount of 
derivative contracts. Specifically, commenters stated that including 
multiple approaches for calculating the exposure amount of derivative 
contracts in the capital rule creates regulatory burden and increases 
the potential for competitive inequalities. The commenters asked the 
agencies to adopt one methodology that all banking organizations would 
be required to use to determine the exposure amount of derivative 
contracts or, short of that, to allow all banking organizations (i.e., 
both advanced approaches and non-advanced approaches banking 
organizations) to elect to use any approach--CEM, SA-CCR, or IMM--to 
determine the exposure amount for all derivative contracts, as long as 
the approach is permitted or required under any of the agencies' rules 
to calculate the exposure amount of derivative contracts. Other 
commenters, however, supported allowing advanced approaches banking 
organizations the option to use IMM for noncleared and cleared 
derivative contracts to facilitate closer alignment with internal risk-
management practices of banking organizations because, according to the 
commenters, SA-CCR may not adapt dynamically to changes in market 
conditions.
    Some commenters also requested changes to the applicability 
criteria for a particular methodology under the capital rule. 
Specifically, commenters asked the agencies to allow advanced 
approaches banking organizations to use IMM to calculate the exposure 
amount of derivative contracts under the standardized approach. Some of 
these commenters also asked the agencies to tailor the application of 
SA-CCR based on the composition of a banking organization's derivatives 
portfolio, rather than solely based on whether the banking organization 
meets the definition of an advanced approaches banking organization.
    Limiting all banking organizations to a single methodology would be 
inconsistent with the agencies' efforts to tailor the application of 
the capital rule to the risk profiles of banking organizations.\28\ In 
particular, while SA-CCR offers several improvements to the regulatory 
capital treatment for derivative contracts relative to CEM, it also 
requires internal systems enhancements and other operational 
modifications that could be particularly burdensome for smaller, less 
complex banking organizations. Moreover, allowing banking organizations 
to use IMM for purposes of determining standardized total risk-weighted 
assets would be inconsistent with an intended purpose of the 
standardized approach, which is to serve as a floor to model-derived 
outcomes under the advanced approaches.
---------------------------------------------------------------------------

    \28\ See id.
---------------------------------------------------------------------------

    The proposal to require advanced approaches banking organizations 
to use either SA-CCR or IMM to determine the exposure amount of their 
noncleared and cleared derivative contracts under the advanced 
approaches provides meaningful flexibility, promotes consistency for 
banking organizations that have substantial operations in multiple 
jurisdictions, and facilitates regulatory reporting and the supervisory 
assessment of an advanced approaches banking organization's capital 
management program. An approach that tailors the applicability of SA-
CCR based solely on the composition of a banking organization's 
derivatives portfolio, as suggested by commenters, would be 
inconsistent with these objectives.
    Consistent with the proposal, the final rule includes CEM, SA-CCR, 
and IMM as methodologies for banking organizations to use to determine 
the exposure amount of derivative contracts and prescribes which 
approach a banking organization must use based on the category of 
standards applicable to the banking organization.\29\ As under the 
capital rule currently, the final rule does not permit advanced 
approaches banking organizations to use IMM to calculate the exposure 
amount of derivative contracts under the standardized approach.
---------------------------------------------------------------------------

    \29\ Id.
---------------------------------------------------------------------------

    Under the final rule and as reflected further in Table 1, an 
advanced approaches banking organization generally may use SA-CCR or 
IMM for purposes of determining advanced approaches total risk-weighted 
assets,\30\ and must use SA-CCR for purposes of determining 
standardized total risk-weighted assets as well as the supplementary 
leverage ratio. A non-advanced approaches banking organization may 
continue to use CEM or elect to use SA-CCR for purposes of the 
standardized approach and supplementary leverage ratio (as 
applicable).\31\ Where a banking organization has the option to choose 
among the approaches applicable to such banking organization under the 
capital rule, it must use the same approach for all purposes. As 
discussed in section II.C of this Supplementary Information, the 
agencies will continue to consider the extent to which SA-CCR should be 
incorporated into areas of the regulatory framework that are not 
addressed under this final rule in the context of separate rulemakings.
---------------------------------------------------------------------------

    \30\ As reflected in Table 1, an advanced approaches banking 
organization must use SA-CCR to determine its exposure to default 
fund contributions under the advanced approaches.
    \31\ The tailoring final rule revised the scope of applicability 
of the supplementary leverage ratio, such that it applies to U.S. 
and foreign banking organizations subject to Category I, Category 
II, or Category III standards. See supra notes 5 and 23. The use of 
SA-CCR for purposes of the supplementary leverage ratio is discussed 
in greater detail in section V of this Supplementary Information.

                               Table 1--Scope and Applicability of the Final Rule
----------------------------------------------------------------------------------------------------------------
                                        Noncleared derivative     Cleared transactions         Default fund
                                              contracts                framework               contribution
----------------------------------------------------------------------------------------------------------------
Advanced approaches banking            Option to use SA-CCR or  Must use the same        Must use SA-CCR.
 organizations, advanced approaches     IMM.                     approach selected for
 total risk-weighted assets.                                     purposes of noncleared
                                                                 derivative contracts.
Advanced approaches banking            Must use SA-CCR........  Must use SA-CCR........  Must use SA-CCR.
 organizations, total risk-weighted
 assets under the standardized
 approach.

[[Page 4368]]

 
Non-advanced approaches banking        Option to use CEM or SA- Must use the same        Must use the same
 organizations, total risk-weighted     CCR.                     approach selected for    approach selected for
 assets under the standardized                                   purposes of noncleared   purposes of noncleared
 approach.                                                       derivative contracts.    derivative contracts.
----------------------------------------------------------------------------------------------------------------
Advanced approaches banking             Must use SA-CCR to determine the exposure amount of derivative contracts
 organizations, supplementary                                 for total leverage exposure.
 leverage ratio.
----------------------------------------------------------------------------------------------------------------
Banking organizations subject to            Option to use CEM or SA-CCR to determine the exposure amount of
 Category III capital standards,        derivative contracts for total leverage exposure. A banking organization
 supplementary leverage ratio.               must use the same approach, CEM or SA-CCR, for purposes of both
                                         standardized total risk-weighted assets and the supplementary leverage
                                                                         ratio.
----------------------------------------------------------------------------------------------------------------

2. Applicability to Certain Derivative Contracts
    The proposal would have required a banking organization to 
calculate the exposure amount for all derivative contracts to which the 
banking organization has an exposure. Commenters raised concerns 
regarding the treatment of certain derivative contracts under the 
proposal. Specifically, several commenters asked the agencies to 
exclude from banking organizations' regulatory capital calculations 
derivative contracts with commercial end-user counterparties, while 
other commenters suggested that the final rule should exclude 
physically settled forward contracts. Other commenters requested that 
the agencies allow advanced approaches banking organizations to 
continue to use CEM to calculate the exposure amount of their 
derivative contracts with commercial end-user counterparties.
    Excluding certain derivative contracts from the application of the 
capital rule, as suggested by commenters, would exclude a material 
source of credit risk from a banking organization's regulatory capital 
requirements. Moreover, requiring a banking organization to use the 
same approach for its entire derivative portfolio when calculating 
either its standardized or advanced approaches total risk-weighted 
assets promotes consistency in the regulatory capital treatment of 
derivative contracts, and facilitates the supervisory assessment of a 
banking organization's capital management program.\32\ Therefore, 
consistent with the proposal, the final rule does not provide an 
exclusion for specific types of derivative contracts nor does it permit 
the use of different methodologies based on the type of derivative 
contract or counterparty.
---------------------------------------------------------------------------

    \32\ The final rule does not revise the FR Y-15 report to 
reflect SA-CCR, as discussed further in section II.C of this 
Supplementary Information.
---------------------------------------------------------------------------

3. Application to New Derivative Contracts and Immaterial Exposures
    Under the current capital rule, an advanced approaches banking 
organization can use CEM for a period of 180 days for material 
portfolios of new derivative contracts and without time limitations for 
immaterial portfolios of new derivative contracts to satisfy the 
requirement that the total exposure amount calculated under IMM must be 
at least equal to the greater of the expected positive exposure amount 
under either the modelled stress scenario or the modelled un-stressed 
scenario multiplied by 1.4.\33\ Some commenters noted that the proposal 
did not replace CEM with SA-CCR for these purposes and suggested 
providing advanced approaches banking organizations the option to 
consider SA-CCR, in place of CEM, to satisfy the same conservatism 
requirements. The agencies recognize that an advanced approaches 
banking organization may need time to develop systems and collect 
sufficient data to appropriately model the exposure amount for material 
portfolios of new derivatives under IMM. Therefore, under the final 
rule, an advanced approaches banking organization that elects to use 
IMM to calculate the exposure amount of its derivative contracts under 
the advanced approaches may use SA-CCR for a period of 180 days for 
material portfolios of new derivative contracts and for immaterial 
portfolios of such contracts without time limitations.\34\ This 
treatment is consistent with the current capital rule.
---------------------------------------------------------------------------

    \33\ See 12 CFR 3.132(d)(10) (OCC); 12 CFR 217.132(d)(10) 
(Board); and 12 CFR 324.132(d)(10) (FDIC).
    \34\ Similar to CEM, as a standardized framework, SA-CCR is 
designed to produce sufficiently conservative exposure amounts, 
compared to those calculated under IMM, that satisfy the 
conservatism requirement under Sec.  __.132(d)(10)(i). The final 
rule also makes similar conforming changes elsewhere in Sec.  
__.132(d) and (e) to incorporate SA-CCR in the place of CEM.
---------------------------------------------------------------------------

B. Effective Date and Compliance Deadline

    The proposal included a transition period, until July 1, 2020, by 
which time all advanced approaches banking organizations would have 
been required to implement SA-CCR; however, both advanced approaches 
and non-advanced approaches banking organizations would have been able 
to adopt SA-CCR as of the effective date of the final rule.
    Several commenters asked the agencies to delay adoption of the 
final rule. Specifically, some of these commenters asked that the 
agencies delay adoption until completion of a comprehensive study on 
the effect of the proposal, including the effect of SA-CCR on 
commercial end-user counterparties. Other commenters also asked the 
agencies to delay adoption of SA-CCR, or alternatively, the mandatory 
compliance date, in order to align its implementation with potential 
forthcoming changes to the U.S. regulatory capital framework that might 
be implemented through separate rulemakings.\35\ These commenters 
expressed concern that the interaction between SA-CCR and related 
aspects of the U.S. regulatory capital framework could result in 
increased capital requirements for banking organizations that are not 
reflective of underlying risk. In addition, some of these commenters 
specifically urged the agencies to pair the adoption of SA-CCR with the 
implementation of the Basel Committee's revised comprehensive approach 
for securities financing transactions.\36\ These commenters argued that 
banking organizations could use derivative transactions as a substitute 
for securities financing

[[Page 4369]]

transactions and, therefore, adopting SA-CCR without implementing the 
revised comprehensive approach for securities financing transactions 
could lead to further concentration in the derivatives market and 
decreases in the liquidity of the securities financing transactions 
market. Alternatively, other commenters urged the agencies to set the 
mandatory compliance date as of January 2022 to align with other 
anticipated changes to the U.S. regulatory capital framework, and 
supported allowing banking organizations to adopt SA-CCR or portions of 
SA-CCR as early as the issuance of the final rule.
---------------------------------------------------------------------------

    \35\ For example, the commenters noted potential changes to the 
regulatory framework as a result of the Basel Committee's December 
2017 release. See ``Basel III: Finalising post-crisis reforms,'' 
Basel Committee on Banking Supervision, December 2017, https://www.bis.org/bcbs/publ/d424.pdf.
    \36\ Id.
---------------------------------------------------------------------------

    Additionally, several commenters asked the agencies to align U.S. 
implementation of SA-CCR with its implementation schedule in other 
jurisdictions, so as not to disadvantage U.S. banking organizations and 
their U.S. clients relative to foreign firms. These commenters argued 
that a mandatory compliance date of January 2022 would ensure 
internationally consistent implementation of SA-CCR across 
jurisdictions and allow banking organizations ample time to implement 
SA-CCR for purposes of both existing regulatory capital requirements 
and any anticipated forthcoming changes to the U.S. regulatory capital 
framework. Other commenters suggested extending the mandatory 
compliance date to January 2022 for banking organizations that use CEM 
currently and do not have extensive derivatives portfolios.
    Conversely, several commenters asked the agencies to adopt the 
proposal as a final rule without delay and to retain the proposed July 
2020 mandatory compliance date. Of these, some commenters suggested 
that the effective date for implementation of SA-CCR should be earlier 
than July 2020 for the entirety or portions of the SA-CCR rule. These 
commenters also asked the agencies to provide interim relief through a 
reduction in risk weights for certain financial products, such as 
options, if the implementation of SA-CCR is delayed.
    The agencies anticipate that the final rule will not materially 
change the amount of capital in the banking system, and that any change 
in a particular banking organization's capital requirements, through 
either an increase or a decrease in regulatory capital, would reflect 
the enhanced risk sensitivity of SA-CCR relative to CEM, as well as 
market conditions.\37\ In addition, SA-CCR provides important 
improvements to risk sensitivity and calibration relative to CEM and is 
responsive to concerns that CEM has not kept pace with market practices 
used by large banking organizations that are active in the derivatives 
market. Therefore, the agencies are not delaying adoption of the final 
rule. The agencies intend to monitor the implementation of SA-CCR as 
part of their ongoing assessment of the effectiveness of the overall 
U.S. regulatory capital framework to determine whether there are 
opportunities to reduce burden and improve its efficiency in a manner 
that continues to support the safety and soundness of banking 
organizations and U.S. financial stability.
---------------------------------------------------------------------------

    \37\ The estimated impact of the final rule is described in 
greater detail in section VII of this SUPPLEMENTARY INFORMATION.
---------------------------------------------------------------------------

    However, the agencies recognize that the implementation of SA-CCR 
requires advanced approaches banking organizations to augment existing 
systems or develop new ones, as all such banking organizations must 
adopt SA-CCR for the standardized approach even if they plan to 
continue using IMM under the advanced approaches. Accordingly, the 
final rule includes a mandatory compliance date for advanced approaches 
banking organizations of January 1, 2022, to permit these banking 
organizations additional time to adjust their systems, as needed, to 
implement SA-CCR. The final rule also includes an effective date 
shortly after publication that permits any banking organization to 
elect to adopt SA-CCR prior to the mandatory compliance date. For this 
reason, the agencies do not believe that it is necessary to provide any 
interim adjustments to the current framework.
    Advanced approaches and non-advanced approaches banking 
organizations that adopt SA-CCR prior to the mandatory compliance date 
must notify their appropriate Federal supervisor. Non-advanced 
approaches banking organizations that adopt SA-CCR after the mandatory 
compliance date also must notify their appropriate Federal supervisor. 
As the final rule does not allow banking organizations to use SA-CCR 
for a material subset of derivative exposures under either the 
standardized or advanced approaches, a banking organization cannot 
early adopt SA-CCR on a partial basis.\38\ In addition, the technical 
revisions in the final rule, as described in section VI of this 
Supplementary Information, are effective as of the effective date of 
the final rule.
---------------------------------------------------------------------------

    \38\ The final rule allows banking organizations that elect to 
use SA-CCR to continue to use method 1 or method 2 under CEM to 
calculate the risk-weighted asset amount for default fund 
contributions until January 1, 2022. See section IV.B. of this 
Supplementary Information for a more detailed discussion on the 
treatment of default fund contributions under the final rule.
---------------------------------------------------------------------------

C. Final Rule's Interaction With Agency Requirements and Other 
Proposals

    The implementation of SA-CCR affects other parts of the regulatory 
framework. Commenters asked that the agencies clarify the interaction 
between SA-CCR and other existing aspects of the framework that would 
be affected by the adoption of SA-CCR, including the FDIC's deposit 
insurance assessment methodology, the Banking Organization Systemic 
Risk Report (FR Y-15), the stress test projections in the Board's 
Comprehensive Capital Analysis and Review (CCAR) process, and the OCC's 
lending limits. Commenters also asked that the agencies clarify the 
interaction between SA-CCR and potential future revisions to the U.S. 
regulatory capital framework, including potential implementation of the 
December 2017 Basel Committee release, Basel III: Finalising post-
crisis reforms (Basel III finalization standard),\39\ and the Board's 
stress capital buffer proposal.
---------------------------------------------------------------------------

    \39\ See supra note 35.
---------------------------------------------------------------------------

1. FDIC Deposit Insurance Assessment Methodology
    Some commenters noted that the adoption of SA-CCR could affect the 
FDIC assessment methodology. In response to this comment, the FDIC 
notes that a lack of historical data on derivative exposure using SA-
CCR makes the FDIC unable to incorporate the SA-CCR methodology into 
the deposit insurance assessment pricing methodology for highly complex 
institutions \40\ upon the effective date of this rule. The FDIC plans 
to review derivative exposure data reported using SA-CCR, and then 
consider options for addressing the use of SA-CCR in the deposit 
insurance assessment system. In the meantime, for purposes of reporting 
counterparty exposures on Schedule RC-O, memorandum items 14 and 15,

[[Page 4370]]

highly complex institutions must continue to calculate derivative 
exposures using CEM (as set forth in 12 CFR 324.34(b) under the final 
rule), but without any reduction for collateral other than cash 
collateral that is all or part of variation margin and that satisfies 
the requirements of 12 CFR 324.10(c)(4)(ii)(C)(1)(ii) and (iii) and 
324.10(c)(4)(ii)(C)(3)-(7) (as amended under the final rule). 
Similarly, highly complex institutions must continue to report the 
exposure amount associated with securities financing transactions, 
including cleared transactions that are securities financing 
transactions, using the standardized approach set forth in 12 CFR 
324.37(b) or (c) (as amended under the final rule). The FDIC is making 
technical amendments to its assessment regulations to update cross-
references to CEM and cash collateral requirements in 12 CFR part 324.
---------------------------------------------------------------------------

    \40\ A ``highly complex institution'' is defined as: (1) An 
insured depository institution (IDI) (excluding a credit card bank) 
that has had $50 billion or more in total assets for at least four 
consecutive quarters that either is controlled by a U.S. parent 
holding company that has had $500 billion or more in total assets 
for four consecutive quarters, or is controlled by one or more 
intermediate U.S. parent holding companies that are controlled by a 
U.S. holding company that has had $500 billion or more in assets for 
four consecutive quarters; or (2) a processing bank or trust 
company. A processing bank or trust company is an IDI whose last 
three years' non-lending interest income, fiduciary revenues, and 
investment banking fees, combined, exceed 50 percent of total 
revenues (and its last three years fiduciary revenues are non-zero), 
whose total fiduciary assets total $500 billion or more and whose 
total assets for at least four consecutive quarters have been $10 
billion or more. See 12 CFR 327.8(g) and (s).
---------------------------------------------------------------------------

2. The Banking Organization Systemic Risk Report (FR Y-15)
    Some commenters noted that the adoption of SA-CCR could affect 
reporting on the Banking Organization Systemic Risk Report (FR Y-15), 
which must be filed by U.S. bank holding companies and certain savings 
and loan holding companies with $100 billion or more in total 
consolidated assets and foreign banking organizations with $100 billion 
or more in combined U.S. assets.\41\ In particular, these commenters 
requested that the agencies exclude the alpha factor from the exposure 
amount calculation under SA-CCR for purposes of the interconnectedness 
indicator under the FR Y-15. The Board expects to address the use of 
SA-CCR for purposes of the FR Y-15 in a separate process. Until such 
time, banking organizations that must report the FR Y-15 should 
continue to use CEM to determine the potential future exposure of their 
derivative contracts for purposes of completing line 11(b) of Schedule 
B, consistent with the current instructions to the form.
---------------------------------------------------------------------------

    \41\ See Reporting Form FR Y-15, Instructions for Preparation of 
Banking Organization Systemic Risk Report (reissued December 2016). 
The Board recently finalized modifications the reporting panel and 
certain substantive requirements of Form FR Y-15 in connection with 
the tailoring final rule adopted by the agencies. See 84 FR 59032 
(November 1, 2019) (Board-only final rule to establish risk-based 
categories for determining prudential standards to large U.S. and 
foreign banking organizations (Board-only tailoring final rule)); 
see also supra note 23.
---------------------------------------------------------------------------

3. Stress Test Projections in CCAR
    Commenters asked the Board to clarify how the implementation of SA-
CCR will interact with the supervisory stress-testing program. In 
particular, some commenters asked the Board to clarify when a banking 
organization must incorporate SA-CCR into any stress test projections 
made for purposes of the Comprehensive Capital Analysis and Review 
(CCAR) exercise relative to the timing of its implementation for 
regulatory capital purposes. Consistent with past capital planning 
practice, the Board expects to make revisions so as to not require a 
banking organization to use SA-CCR for purposes of the CCAR exercise 
prior to adopting SA-CCR to calculate its risk-based and supplementary 
leverage capital requirements (as applicable) under the capital rule. 
To promote comparability of stress test results across banking 
organizations, for the 2020 stress test cycle all banking organizations 
would continue to use CEM for the CCAR exercise. However, a banking 
organization that has elected to adopt SA-CCR in 2020 would be required 
to use SA-CCR for the CCAR exercise beginning with the 2021 stress test 
cycle, and those who adopt in 2021 must use SA-CCR for the CCAR 
exercise beginning with 2022 stress test cycle.\42\ Finally, a banking 
organization that does not adopt SA-CCR until the mandatory compliance 
date in 2022 would not be required to use SA-CCR for the CCAR exercise 
until the 2023 and all subsequent stress test cycles. Prior to the time 
of adoption in stress testing, the Board expects to update the Form FR 
Y-14 to implement these changes and to provide any necessary 
information on how to incorporate SA-CCR into a banking organization's 
stress test results.\43\
---------------------------------------------------------------------------

    \42\ For banking organizations subject to Category IV 
supervisory stress test requirements, 2022 is an on-cycle year.
    \43\ Banking organizations that report information on the FR Y-
14 under SA-CCR must do so for all schedules, including DFAST and 
CCAR. The anticipated standards described in this section would 
apply equally for purposes of DFAST and CCAR.
---------------------------------------------------------------------------

    Commenters also suggested aligning certain aspects of the CCAR 
exercise with SA-CCR. Specifically, commenters asked the Board to 
revise the CCAR methodology for estimating losses under the largest 
single counterparty default scenario to distinguish between margined 
and unmargined counterparty relationships in a manner consistent with 
SA-CCR. The methodologies for measuring counterparty exposure under SA-
CCR and supervisory stress testing are designed to capture different 
types of risks. In particular, the largest single counterparty default 
exercise seeks to ensure that a banking organization can absorb losses 
associated with the default of any counterparty, in addition to losses 
associated with adverse economic conditions, in an environment of 
economic uncertainty. The Board regularly reviews its stress testing 
models, and will continue to evaluate the appropriateness of 
assumptions related to the largest counterparty default component.
4. Swap Margin Rule
    Commenters noted that the agencies' margin and capital requirements 
for covered swap entities rule (swap margin rule) uses a methodology 
similar to CEM to quantify initial margin requirements for non-cleared 
swaps and non-cleared security-based swaps.\44\ This final rule does 
not affect the swap margin rule or the calculation of appropriate 
margin and, therefore, the implementation of SA-CCR will not require a 
banking organization to change the way it complies with those 
requirements.
---------------------------------------------------------------------------

    \44\ See supra note 17.
---------------------------------------------------------------------------

5. OCC Lending Limits
    In the proposal, the OCC proposed to revise its lending limit rule 
at 12 CFR part 32, to update cross-references to CEM in the 
standardized approach and to permit SA-CCR as an option for calculation 
of exposures under lending limits. Commenters generally supported the 
OCC's proposal to align measurement of counterparty credit risk across 
regulatory requirements. The OCC agrees with the commenters and 
therefore the final rule adopts revisions to the lending limits rule as 
proposed.
6. Single Counterparty Credit Limit (SCCL)
    As noted in the proposal, the Board's single counterparty credit 
limit (SCCL) rule authorizes a banking organization subject to the SCCL 
to use any methodology that such a banking organization is authorized 
to use under the capital rule to determine the credit exposure 
associated with a derivative contract for purposes of the SCCL 
rule.\45\ Thus, as under the proposal, as of the mandatory compliance 
date for SA-CCR, to determine the credit exposure associated with a 
derivative contract under the SCCL rule, an advanced approaches banking 
organization must use SA-CCR or IMM and a banking organization subject 
to Category III standards, which include the SCCL rule, must use 
whichever of CEM or SA-CCR

[[Page 4371]]

that it uses to calculate its standardized total risk-weighted assets.
---------------------------------------------------------------------------

    \45\ See 83 FR 38460 (August 6, 2018). The Board-only tailoring 
final rule revised the scope of applicability of the SCCL rule, such 
that it applies to U.S. and foreign banking organizations subject to 
Category I, II, or III standards, as applicable, and foreign banking 
organizations with global consolidated assets of $250 billion or 
more. See supra note 41.
---------------------------------------------------------------------------

7. Potential Future Revisions to the Agencies' Rules
    Commenters requested additional information on the interaction of 
SA-CCR with other potential revisions that the agencies may make to 
their respective regulatory capital rules. Potential revisions 
identified by commenters included the implementation of the Basel III 
finalization standard and the Board's proposal to integrate the capital 
rule and CCAR and stress test rules published in April 2018.\46\ In 
addition, the proposed net stable funding ratio rule would cross-
reference netting provisions of the agencies' supplementary leverage 
ratio that are amended under the final rule.\47\ The agencies will 
consider the calibration and operation of SA-CCR for purposes of any 
such potential revisions through the rulemaking process.
---------------------------------------------------------------------------

    \46\ See 83 FR 18160 (April 25, 2018).
    \47\ See 81 FR 35124 (June 1, 2016).
---------------------------------------------------------------------------

III. Mechanics of the Standardized Approach for Counterparty Credit 
Risk

A. Exposure Amount

    Under the proposal, the exposure amount of a netting set would have 
been equal to an alpha factor of 1.4 multiplied by the sum of the 
replacement cost of the netting set and the PFE of the netting set. The 
purposes of the alpha factor were to address certain risks that are not 
captured under SA-CCR and to ensure that exposure amounts produced 
under SA-CCR generally would not be lower than those under IMM, in 
support of its use as a broadly applicable and standardized 
methodology. In addition, the proposal would have set the exposure 
amount at zero for a netting set that consists of only sold options in 
which the counterparty to the options paid the premiums up front and 
that the options within the netting set are not subject to a variation 
margin agreement.
    Commenters stated that the proposal would increase the exposure 
amount of derivative contracts with commercial end-users, relative to 
CEM, because commercial end-users often have directional, unmargined 
derivative portfolios, which would not receive the benefits of 
collateral recognition and netting under SA-CCR in the form of a 
reduction to the replacement cost and PFE amounts. As a result, 
commenters expressed concern that banking organizations would pass the 
costs of higher capital to commercial end-users in the form of higher 
fees or, alternatively, that banking organizations could be less 
willing to engage in derivative contracts with commercial end-users who 
may lack the capability and scale to provide financial collateral 
recognized under the capital rule. Commenters also expressed concern 
that any increase in hedging costs for commercial end-users could have 
an adverse impact on the broader economy.
    Commenters generally suggested that the agencies address these 
issues through changes to the alpha factor, either by removing it for 
all derivative contracts with commercial end-user counterparties, or 
only for such contracts that are unmargined. Commenters asserted that 
providing relief for derivative contracts with commercial end-user 
counterparties would not undermine the goals of the proposal because 
these transactions comprise a small percentage of outstanding 
derivatives and may present less risk than other directional, 
unmargined derivatives. In support of this assertion, commenters argued 
that commercial end-users typically provide collateral that is not 
recognized as financial collateral under the capital rule but 
nonetheless reduces the counterparty credit risk of the underlying 
transaction.\48\ Commenters also argued that removing or reducing the 
alpha factor for such derivative contracts would be consistent with 
congressional and regulatory efforts designed to facilitate the ability 
of such counterparties to enter into derivative contracts to manage 
commercial risks.\49\
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    \48\ The types of collateral that commercial end-users provide 
that do not qualify as financial collateral under the capital rule 
are discussed in further detail in section III.B. of this 
SUPPLEMENTARY INFORMATION.
    \49\ See supra note 17.
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    Some commenters argued that applying the alpha factor to derivative 
contracts with commercial end-user counterparties is misaligned with 
the risks that the alpha factor was intended to address under IMM, such 
as wrong-way risk.\50\ Some commenters recommended reducing the alpha 
factor to 0.65 for derivative contracts with investment grade 
commercial end-user counterparties, or with non-investment grade 
commercial end-user counterparties that are supported by a letter of 
credit or provide a first-priority lien on assets that do not present 
wrong-way risk with respect to the underlying derivative contract. 
These commenters argued that reducing the alpha factor to 0.65 would 
improve risk sensitivity and more closely align with the treatment of 
investment-grade corporate exposures under the revised Basel III 
finalization standard.\51\
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    \50\ Wrong way risk means that the size of an exposure is 
positively correlated with the counterparty's probability of 
default--that is, the exposure amount of the derivative contract 
increases as the counterparty's probability of default increases.
    \51\ See supra note 3555.
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    The agencies recognize that derivative contracts between banking 
organizations and commercial end-users may include credit risk 
mitigants that do not qualify as financial collateral under the capital 
rule.\52\ In addition, and in contrast to derivative contracts with 
financial end-users, derivative contracts with commercial end-users 
have heightened potential to present right-way risk.\53\ The final rule 
removes the alpha factor from the exposure amount formula for 
derivative contracts with commercial end-user counterparties. The 
agencies intend for this treatment to better align with the 
counterparty credit risk presented by such exposures due to the 
presence of credit risk mitigants and the potential for such 
transactions to present right-way risk. In particular, the agencies 
recognize that derivative exposures to commercial end-user 
counterparties may be less likely to present the types of risks that 
the alpha factor was designed to address, as discussed previously, and 
therefore believe that removing the alpha factor for such exposures 
improves the calibration of SA-CCR. The agencies note that this 
approach also may mitigate the concerns of commenters regarding the 
potential effects of the proposal relative to congressional and other 
regulatory actions designed to mitigate the effect that post-crisis 
derivatives market reforms have on the ability of these parties to 
enter into derivative contracts to manage commercial risks. The 
agencies intend to monitor the implementation of SA-CCR as part of 
their ongoing assessment of the effectiveness of the overall U.S. 
regulatory capital framework to determine whether there are 
opportunities to improve the ability of commercial end-users to enter 
into derivative contracts with banking organizations in a manner that 
continues to support the safety and soundness of banking organizations 
and U.S. financial stability.
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    \52\ Under Sec.  _.2 of the capital rule, financial collateral 
means cash or liquid and readily marketable securities, in which a 
banking organization has a perfected first-priority security 
interest in the collateral. See 12 CFR 3.2 (OCC); 12 CFR 217.2 
(Board); and 12 CFR 324.2 (FDIC).
    \53\ Right way risk means that the size of an exposure is 
negatively correlated with the counterparty's probability of 
default--that is, the exposure amount of the derivative contract 
decreases as the counterparty's probability of default increases.
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    Beyond the concerns related to commercial end-users, commenters

[[Page 4372]]

recommended other changes to the alpha factor. Several commenters 
suggested removing the alpha factor from the SA-CCR methodology 
altogether, whereas other commenters suggested that the alpha factor 
should apply only to the PFE component. Some commenters supported 
reducing or eliminating the alpha factor as it applies to all or a 
subset of derivative contracts.
    Commenters that recommended removing the alpha factor argued that 
the rationale for adopting the alpha factor for purposes of IMM does 
not apply in the context of SA-CCR because, in contrast to IMM, SA-CCR 
is a non-modelled approach and does not require an adjustment to 
account for model risk. Similarly, other commenters noted that the 
alpha factor is less meaningful in the United States because, under the 
capital rule, the standardized approach serves as a floor to the 
advanced approaches for total risk-weighted assets. Some of these 
commenters also stated that the potential elimination of the advanced 
approaches in connection with the U.S. implementation of the Basel III 
finalization standard would eliminate use of IMM and undermine the need 
for the alpha factor. Other commenters argued that because IMM 
incorporates relatively higher stressed-volatility inputs while the 
supervisory factors under SA-CCR are static, attempts to have SA-CCR 
yield a more conservative exposure amount than IMM in all cases could 
result in SA-CCR producing excessive capital requirements that are 
disconnected from the actual risk of the underlying exposures. 
Alternatively, other commenters recommended only applying the alpha 
factor to PFE. These commenters argued that applying the alpha factor 
to replacement cost would be inappropriate as the fair value of on-
balance sheet derivatives are not subject to model uncertainty.
    Commenters that supported reducing the alpha factor recommended 
revising the calibration to reflect the derivatives market reforms that 
followed the financial crisis, such as mandatory clearing requirements 
promulgated by the Commodity Futures Trading Commission (CFTC) \54\ and 
the swap margin rule.\55\ Of these, some commenters supported applying 
a lower alpha factor to heavily over-collateralized portfolios in order 
to provide greater collateral recognition.
---------------------------------------------------------------------------

    \54\ See 17 CFR part 50.
    \55\ See supra note 17.
---------------------------------------------------------------------------

    Additionally, some commenters expressed concern that the alpha 
factor could adversely affect custody banking organizations. In 
particular, the commenters asserted that custody banking organizations 
do not maintain large portfolios of derivative contracts across a broad 
range of tenors (i.e., the amount of time remaining before the end date 
of the derivative contract) and asset classes and that the foreign 
exchange derivative portfolio of a custody banking organization is 
intended to serve the investment needs of the custody banking 
organization's clients rather than to take on economic risk.
    In contrast, some commenters who supported the alpha factor 
suggested that concerns regarding its impact on the exposure amount 
calculated under SA-CCR are overstated. Specifically, these commenters 
argued that banking organizations have incentives to minimize estimates 
of risk for regulatory capital purposes and that internal models failed 
to account properly for risk during the crisis and have been criticized 
in analyses conducted since then. In addition, these commenters stated 
that although SA-CCR uses estimates of volatility for individual 
positions that are based on observed, crisis period volatilities, 
greater recognition of netting and margin under SA-CCR may fully offset 
any conservatism resulting from the use of updated volatility 
estimates.
    As noted in the proposal, the alpha factor helps to instill an 
appropriate level of conservatism and further support the use of SA-CCR 
as a broadly applicable and standardized methodology. Additionally, the 
alpha factor serves to capture certain risks (e.g., wrong-way risk, 
non-granular risk exposures, etc.) that are not fully reflected under 
either IMM or SA-CCR. Adopting commenters' recommendations could reduce 
the efficacy of SA-CCR as a standardized approach that serves a floor 
to internal models-based approaches. For large, internationally active 
banking organizations, consistency with the Basel Committee standard 
also helps to reduce operational burden and minimize any incentives 
such banking organizations may have to book activities in legal 
entities located in jurisdictions that provide relatively more 
favorable regulatory capital treatment.
    Accordingly, the final rule incorporates an alpha factor of 1.4 in 
the exposure amount formula, except as it applies to derivative 
contracts with commercial end-user counterparties for which the alpha 
factor is removed under the final rule. The exposure amount formulas 
are represented as follows:

exposure amount = 1.4 * (replacement cost + PFE).

    However, for a derivative contract with a commercial end-user 
counterparty, the exposure amount is represented as follows:

exposure amount = (replacement cost + PFE).

    To operationalize the exposure amount formula for derivative 
contracts with commercial end-user counterparties, the final rule 
provides a definition of commercial end-user. Under the final rule, a 
commercial end-user means a company that is using derivatives to hedge 
or mitigate commercial risk, and is not a financial entity listed in 
section 2(h)(7)(C)(i)(I) through (VIII) of the Commodity Exchange Act 
\56\ or is not a financial entity listed in section 3C(g)(3)(A)(i) 
through (viii) of the Securities Exchange Act.\57\ The definition also 
includes an entity that qualifies for the exemption from clearing under 
section 2(h)(7)(A) of the Commodity Exchange Act by virtue of section 
2(h)(7)(D) of the Commodity Exchange Act, including entities that are 
exempted from the definition of financial entity under section 
2(h)(7)(C)(iii) of the Commodity Exchange Act; \58\ or qualifies for 
the exemption from clearing under section 3C(g)(1) of the Securities 
Exchange Act by virtue of section 3C(g)(4) of the Securities Exchange 
Act.\59\ Including these entities within the commercial end-user 
definition permits affiliates that hedge commercial risks on behalf of 
a parent entity that is not a financial entity to qualify as a 
commercial end-user, which would accommodate business organizations 
that hedge commercial risks through transactions conducted by 
affiliates rather than directly by the parent company. Overall, the 
definition covers commercial end-users and generally excludes financial 
entities.
---------------------------------------------------------------------------

    \56\ 7 U.S.C. 2(h)(7)(C)(i)(I) through (VIII). The commercial 
end-user definition also applies to transactions with affiliates of 
entities that enter into derivative contracts on behalf of those 
entities that meet the criteria under section 2(h)(7)(D) of the 
Commodity Exchange Act.
    \57\ 15 U.S.C. 78c-3(g)(3)(A)(i) through (viii).
    \58\ 7 U.S.C. 2(h)(7)(A), (C)(iii), and (D).
    \59\ 15 U.S.C. 78c-3(g)(1) and (4).
---------------------------------------------------------------------------

    This definition has the advantage of being generally consistent 
with other regulations promulgated by the agencies, including the swap 
margin rule.\60\ Referencing provisions of the Commodities Exchange Act 
or Securities Exchange Act promotes consistency with other regulations 
and offers a significant compliance benefit to

[[Page 4373]]

institutions subject to the final rule.\61\ In addition, in the swap 
margin rule context, the agencies observed that differences in risk 
profiles justified distinguishing between financial end-users and non-
financial end-users, on the grounds that financial firms present a 
higher level of risk than other types of counterparties and are more 
likely to default during a period of financial stress, thus posing 
greater risk to the safety and soundness of the counterparty and 
systemic risk.\62\ While some commenters requested an exemption for 
entities that was slightly narrower or broader than the definition the 
agencies are adopting in the final rule, as noted above, the 
distinction drawn by this definition is appropriate to differentiate 
derivative transactions that have the potential to present right-way 
risk from those that do not.\63\
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    \60\ See supra note 17.
    \61\ The definition of a commercial end-user in the final rule 
does not extend to an organization exempted by the CFTC pursuant to 
section 2(h)(7)(C)(ii) of the Commodity Exchange Act (7 U.S.C. 
2(h)(7)(C)(ii)) or exempted by the Securities and Exchange 
Commission pursuant to section 3C(g)(3)(B) of the Securities 
Exchange Act of 1934 (15 U.S.C. 78c-3(g)(3)(B)).
    \62\ See 80 FR 74839, 74853 (April 1, 2016).
    \63\ Id.
---------------------------------------------------------------------------

    Other commenters asked the agencies to clarify that the proposal 
would apply an exposure amount of zero to sold options in which the 
counterparty to the options has paid the premiums up front and that are 
not subject to a variation margin agreement. Consistent with the 
proposal, under the final rule, an exposure amount of zero applies to 
sold options that are not subject to a variation margin agreement and 
for which the counterparty has paid the premiums up front.\64\ This 
treatment is appropriate because the counterparty to the option has no 
future payment obligation under the derivative contract and the banking 
organization, as the option seller, has no exposure to counterparty 
credit risk.
---------------------------------------------------------------------------

    \64\ See Sec.  _.132(c)(5)(iii) of the final rule.
---------------------------------------------------------------------------

B. Definition of Netting Sets and Treatment of Financial Collateral

    Under the capital rule, a netting set is currently defined as a 
group of transactions with a single counterparty that are subject to a 
qualifying master netting agreement (QMNA) or a qualifying cross-
product master netting agreement. The proposal would have revised the 
definition of netting set to mean either one derivative contract 
between a banking organization and a single counterparty, or a group of 
derivative contracts between a banking organization and a single 
counterparty that are subject to the same qualifying master netting 
agreement or the same qualifying cross-product master netting 
agreement. The proposal would have allowed a banking organization to 
calculate the exposure amount of multiple derivative contracts under 
the same netting set so long as each derivative contract is subject to 
the same QMNA.
    Some commenters raised concerns with the proposal's reliance on 
netting to reduce exposure amounts on a point-in-time basis instead of 
on a dynamic basis and suggested revising the proposal to account for 
situations that may arise during stress periods that could disrupt the 
availability of netting. As an example, the commenters noted that 
during the financial crisis some banking organizations requested to 
novate their ``in-the-money'' derivative contracts with another 
counterparty, while leaving the banking organization's ``out-of-the-
money'' positions with the initial counterparty. The agencies believe 
it is appropriate to allow for the netting of derivative contracts 
under SA-CCR on a point-in-time basis, as allowing for netting on a 
point-in-time basis under SA-CCR is consistent with U.S. generally 
accepted accounting principles (U.S. GAAP) and facilitates 
implementation of the final rule. The capital rule relies significantly 
on banking organizations' U.S. GAAP balance sheets and thus requires 
banking organizations to determine capital ratios on a point-in-time 
basis. The risks related to stress events identified by the commenters 
may be further addressed in the context of stress testing and 
resolution planning. Thus, the agencies are adopting as final the 
netting treatment under the proposal, with the exception of the 
availability of netting among collateralized-to-market and settled-to-
market derivative contracts, which is discussed below in section 
III.D.4. of this SUPPLEMENTARY INFORMATION.
    Under the final rule, a group of derivative contracts subject to 
the same QMNA are part of the same netting set.\65\ In general, a QMNA 
means a netting agreement that permits a banking organization to 
terminate, close-out on a net basis, and promptly liquidate or set off 
collateral upon an event of default of the counterparty.\66\ To qualify 
as a QMNA, the netting agreement must satisfy certain operational 
requirements under Sec.  _.3 of the capital rule.\67\
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    \65\ The definition of netting set also clarifies that a netting 
set can be composed of a single derivative contract and retains 
certain components of the definition that are specific to IMM.
    \66\ See supra note 2. In 2017, the agencies adopted a final 
rule that requires GSIBs and the U.S. operations of foreign GSIBs to 
amend their qualified financial contracts to prevent their immediate 
cancellation or termination if such a banking organization enters 
bankruptcy or a resolution process. Qualified financial contracts 
include derivative contracts, securities lending, and short-term 
funding transactions such as repurchase agreements. Under the 2017 
final rule, the agencies revised the definition of QMNA under the 
capital rule such that qualified financial contracts could be 
subject to a QMNA (notwithstanding other operational requirements). 
See 82 FR 42882 (September 12, 2017).
    \67\ See supra note 2.
---------------------------------------------------------------------------

    Some commenters expressed concern that the proposed definition of 
netting set could inadvertently affect the treatment for repo-style 
transactions under other provisions of the capital rule. The proposed 
definition was intended to reflect that under SA-CCR a banking 
organization would determine the exposure amount for a derivative 
contract at the netting set level, which would have included a single 
derivative contract. However, to address the commenters' concern, the 
agencies have revised the definition of netting set under the final 
rule to mean a group of transactions with a single counterparty that 
are subject to a QMNA and, with respect to derivative contracts only, 
also includes a single derivative contract between a banking 
organization and a counterparty.\68\ With respect to repo-style 
transactions, this definition is consistent with the current capital 
rule.
---------------------------------------------------------------------------

    \68\ Consistent with the current definition of netting set, for 
purposes of the internal models methodology in Sec.  _.132(d) of the 
capital rule, netting set also includes a qualifying cross-product 
master netting agreement. See 12 CFR 3.132(d) (OCC); 12 CFR 
217.132(d) (Board); and 12 CFR 324.132(d) (FDIC).
---------------------------------------------------------------------------

    The proposal set forth definitions for variation margin, variation 
margin amount, independent collateral, and net independent collateral 
amount. The proposal would have defined variation margin as financial 
collateral that is subject to a collateral agreement and provided by 
one party to its counterparty to meet the performance of the first 
party's obligations under one or more derivative contracts between the 
parties as a result of a change in value of such obligations since the 
last exchange of such collateral. The variation margin amount would 
have been equal to the fair value amount of the variation margin that a 
counterparty to a netting set has posted to a banking organization less 
the fair value amount of the variation margin posted by the banking 
organization to the counterparty.
    The proposal would have required the variation margin amount to be 
adjusted by the existing standard supervisory haircuts under Sec.  
_.132(b)(2)(ii)(A)(1) of the capital rule. The standard supervisory 
haircuts reflect potential

[[Page 4374]]

future changes in the value of the financial collateral by adjusting 
for any potential decrease in the value of the financial collateral 
received by a banking organization and any potential increase in the 
value of the financial collateral posted by the banking organization 
over supervisory-provided holding periods. The standard supervisory 
haircuts are based on a ten-business-day holding period, and the 
capital rule requires a banking organization to adjust, as applicable, 
the standard supervisory haircuts to align with the associated 
derivative contract (or repo-style transaction) according to the 
formula in Sec.  _.132(b)(2)(ii)(A)(4).\69\
---------------------------------------------------------------------------

    \69\ As described in section III.D. of this SUPPLEMENTARY 
INFORMATION, the final rule applies a five-day holding period for 
the purpose of the margin period of risk to all derivative contracts 
subject to a variation margin agreement that are client-facing 
derivative transactions, as defined in the final rule, regardless of 
the method the banking organization uses to calculate the exposure 
amount of the derivative contract. As described in section VI.E. of 
this SUPPLEMENTARY INFORMATION, the collateral haircuts for such 
transactions similarly reflect a five-business-day holding period 
under the final rule.
---------------------------------------------------------------------------

    The proposal would have defined independent collateral as financial 
collateral, other than variation margin, that is subject to a 
collateral agreement, or in which a banking organization has a 
perfected, first-priority security interest or, outside of the United 
States, the legal equivalent thereof (with the exception of cash on 
deposit and notwithstanding the prior security interest of any 
custodial agent or any prior security interest granted to a CCP in 
connection with collateral posted to that CCP), and the amount of which 
does not change directly in response to the change in value of the 
derivative contract or contracts that the financial collateral secures.
    Net independent collateral amount would have been defined as the 
fair value amount of the independent collateral that a counterparty to 
a netting set has posted to a banking organization less the fair value 
amount of the independent collateral posted by the banking organization 
to the counterparty, excluding such amounts held in a bankruptcy-remote 
manner,\70\ or posted to a qualifying central counterparty (QCCP) \71\ 
and held in conformance with the operational requirements in Sec.  _.3 
of the capital rule. As with the variation margin amount, the 
independent collateral amount would have been subject to the standard 
supervisory haircuts under Sec.  _.132(b)(2)(ii)(A)(1) of the capital 
rule.
---------------------------------------------------------------------------

    \70\ ``Bankruptcy remote'' is defined in Sec.  _.2 of the 
capital rule. See 12 CFR 3.2 (OCC); 12 CFR 217.2 (Board); and 12 CFR 
324.2 (FDIC).
    \71\ ``Qualifying central counterparty'' is defined in Sec.  _.2 
of the capital rule. See 12 CFR 3.2 (OCC); 12 CFR 217.2 (Board); and 
12 CFR 324.2 (FDIC).
---------------------------------------------------------------------------

    The agencies did not receive comment on the proposed definitions of 
variation margin, variation margin amount, independent collateral, and 
independent collateral amount. Several commenters, however, advocated 
for recognition of alternative collateral arrangements under SA-CCR to 
address the potential impact of the proposal on derivative contracts 
with certain counterparties, including commercial end-users. As noted 
above, the commenters argued that SA-CCR could unduly increase capital 
requirements for derivative exposures to commercial end-user 
counterparties because they often do not provide collateral in the form 
of cash or liquid and readily marketable securities. Commenters stated 
that companies, including commercial end-users, regularly use 
alternative security arrangements, such as liens on assets, a letter of 
credit, or a parent company guarantee, to offset the counterparty 
credit risk of their derivative contracts, and that banking 
organizations should be able to recognize the credit risk-mitigating 
benefits of such arrangements under SA-CCR.
    In support of their recommendation, commenters noted that a line of 
credit functions similarly to the exchange of margin because the line 
of credit is available to be drawn upon by the banking organization in 
advance of default as the counterparty's creditworthiness deteriorates. 
Moreover, the line of credit can be structured so that its amount may 
increase over the life of the derivative contract based on certain 
credit quality metrics. Commenters added that common industry practice 
allows banking organizations to accept these forms of collateral from 
counterparties and to reflect their credit risk-mitigating benefits 
when they calculate the exposure amount under IMM. Commenters also 
argued that derivative contracts with commercial end-users may present 
right-way risk for banking organizations, in contrast to derivative 
contracts with financial institution counterparties, and that this 
feature of these transactions supports recognition of alternative forms 
of collateral.
    The capital rule only recognizes certain forms of collateral that 
qualify as ``financial collateral,'' as defined under the rule.\72\ In 
general, the items that qualify as financial collateral under the 
capital rule exhibit sufficient liquidity and asset quality to serve as 
credit risk mitigants for risk-based capital purposes. Consistent with 
the capital rule, the final rule does not recognize the alternative 
collateral arrangements suggested by commenters. Liens and asset 
pledges, by contrast, may not be rapidly available to support losses in 
an event of default because the assets they attach to can be illiquid 
and thus difficult to value and sell for cash after enforcement of a 
security interest in the collateral or foreclosure, which is 
inconsistent with the principle that derivatives should be able to be 
closed out easily and quickly in an event of default.\73\ In addition, 
recognizing letters of credit would add significant complexity to the 
capital rule. In particular, recognition of letters of credit as 
financial collateral would require the introduction of appropriate 
qualification criteria, as well as a framework for considering the 
counterparty credit risk of institutions providing the letters of 
credit. The agencies also believe that the removal of the alpha factor 
for derivative contract exposures to commercial end-users helps to 
address commenters' concerns that the proposal would have resulted in 
unduly high risk-weighted asset amounts for derivative contracts with 
commercial end-user counterparties.
---------------------------------------------------------------------------

    \72\ See supra note 52.
    \73\ The Board and OCC issued the capital rule as a joint final 
rule on October 11, 2013 (78 FR 62018) and the FDIC issued the 
capital rule as a substantially identical interim final rule on 
September 10, 2013 (78 FR 53340). In April 14, 2014, the FDIC issued 
the interim final rule as a final rule with no substantive changes 
(79 FR 20754).
---------------------------------------------------------------------------

    Accordingly, the agencies are adopting without change the proposed 
definitions for variation margin, independent collateral, variation 
margin amount, and independent collateral amount, as well as the 
proposed application of the standard supervisory haircuts under the 
capital rule.

C. Replacement Cost

    The proposal would have provided separate formulas to determine 
replacement cost that apply depending on whether the counterparty to a 
banking organization is required to post variation margin. 
Specifically, the replacement cost for a netting set that is not 
subject to a variation margin agreement would have equaled the greater 
of (1) the sum of the fair values (after excluding any valuation 
adjustments) of the derivative contracts within the netting set, less 
the net independent collateral amount applicable to such derivative 
contracts, or (2) zero.\74\
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    \74\ Replacement cost is calculated based on the assumption that 
the counterparty has defaulted. Therefore, this calculation cannot 
include valuation adjustments based on counterparty's credit 
quality, such as CVA, which reflect the discounted present value of 
losses if the counterparty were to default in the future.

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[[Page 4375]]

    For a netting set that is subject to a variation margin agreement 
where the counterparty is required to post variation margin, 
replacement cost would have equaled the greater of (1) the sum of the 
fair values (after excluding any valuation adjustments) of the 
derivative contracts within the netting set, less the sum of the net 
independent collateral amount and the variation margin amount 
applicable to such derivative contracts; (2) the sum of the variation 
margin threshold and the minimum transfer amount applicable to the 
derivative contracts within the netting set, less the net independent 
collateral amount applicable to such derivative contracts; or (3) zero. 
As noted in the proposal, the formula to determine the replacement cost 
of a netting set subject to a variation margin agreement would have 
accounted for the maximum possible unsecured exposure amount of the 
netting set that would not trigger a variation margin call. For 
example, a netting set with a high variation margin threshold has a 
higher replacement cost compared to an equivalent netting set with a 
lower variation margin threshold. Therefore, the proposal would have 
provided definitions for variation margin threshold and the minimum 
transfer amount.
    Under the proposal, the variation margin threshold would have meant 
the maximum amount of a banking organization's credit exposure to its 
counterparty that, if exceeded, would require the counterparty to post 
variation margin to the banking organization. The minimum transfer 
amount would have meant the smallest amount of variation margin that 
may be transferred between counterparties to a netting set. The 
proposal included this treatment to address transactions for which the 
variation margin agreement includes a variation margin threshold that 
is set at a level high enough to make the netting set effectively 
unmargined. In such a case, the variation margin threshold would result 
in an inappropriately high replacement cost, because it is not 
reflective of the risk associated with the derivative contract but 
rather the terms of the variation margin agreement. To address this 
issue, the proposal would have provided that the exposure amount of a 
netting set subject to a variation margin agreement could not exceed 
the exposure amount of the same netting set calculated as if the 
netting set were not subject to a variation margin agreement.\75\
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    \75\ There could be a situation unrelated to the value of the 
variation margin threshold in which the exposure amount of a 
margined netting set is greater than the exposure amount of an 
equivalent unmargined netting set. For example, in the case of a 
margined netting set composed of short-term transactions with a 
residual maturity of ten business days or less, the risk horizon 
equals the MPOR, which under the final rule is set to a minimum 
floor of ten business days. The risk horizon for an equivalent 
unmargined netting set also is set to ten business days because this 
is the floor for the remaining maturity of such a netting set. 
However, the maturity factor for the margined netting set is greater 
than the one for the equivalent unmargined netting set because of 
the application of a factor of 1.5 to margined derivative contracts. 
In such an instance, the exposure amount of a margined netting set 
is more than the exposure amount of an equivalent unmargined netting 
set by a factor of 1.5, thus triggering the cap. In addition, in the 
case of margin disputes, the MPOR of a margined netting set is 
doubled, which could further increase the exposure amount of a 
margined netting set comprised of short-term transactions with a 
residual maturity of ten business days or less above an equivalent 
unmargined netting set. The agencies believe, however, that such 
instances rarely occur and thus would have minimal effect on banking 
organizations' regulatory capital. Therefore, the final rule limits 
the exposure amount of a margined netting set to no more than the 
exposure amount of an equivalent unmargined netting set. However, 
the agencies expect to monitor the application of this treatment 
under the final rule.
---------------------------------------------------------------------------

    In addition, the proposal would have provided adjustments for 
determining the replacement cost of a netting set that is subject to 
multiple variation margin agreements or a hybrid netting set, which is 
a netting set composed of at least one derivative contract subject to a 
variation margin agreement under which the counterparty must post 
variation margin and at least one derivative contract that is not 
subject to such a variation margin agreement, and for multiple netting 
sets subject to a single variation margin agreement.
    Some commenters supported the proposed replacement cost calculation 
and, in particular, the cap based on the margin exposure threshold and 
minimum transfer amount. The commenters argued that the unmargined 
exposure amount more accurately reflects the exposure amount for short-
dated trades subject to a higher MPOR, as the close-out period 
reflected in MPOR cannot be increased beyond the maturity of the 
transactions. Other commenters advocated subtracting incurred CVA from 
the exposure amount of a netting set. In support of their 
recommendation, the commenters noted that IMM allows incurred CVA to be 
subtracted from EAD, and that the agencies previously extended such 
treatment to advanced approaches banking organizations that use CEM to 
calculate advanced approaches risk-weighted assets.
    The final rule adopts the proposed replacement cost formulas and 
related definitions, with one modification. The agencies recognize that 
in determining the fair value of a derivative on a banking 
organization's balance sheet, the recognized CVA on the netting set of 
OTC derivative contracts is intended to reflect the credit quality of 
the counterparty. The final rule permits advanced approaches banking 
organizations to reduce EAD, calculated according to SA-CCR, by the 
recognized CVA on the balance sheet, for the purposes of calculating 
advanced approaches total risk-weighted assets. This treatment is 
consistent with the recognition of CVA under CEM as it applies to 
advanced approaches banking organizations that use CEM for purposes of 
determining advanced approaches total risk-weighted assets.\76\
---------------------------------------------------------------------------

    \76\ See 80 FR 41409 (July 15, 2015).
---------------------------------------------------------------------------

    The final rule otherwise adopts without change the proposed 
replacement cost formulas and related definitions, as well as the 
proposed treatment to cap the exposure amount for a margined netting 
set at the maximum exposure amount for an unmargined, but otherwise 
identical, netting set.
    Under Sec.  _.132(c)(6)(ii) of the final rule, the replacement cost 
of a netting set that is not subject to a variation margin agreement is 
represented as follows:

replacement cost = max{V-C; 0{time} ,

Where:

V is the fair values (after excluding any valuation adjustments) of 
the derivative contracts within the netting set; and
C is the net independent collateral amount applicable to such 
derivative contracts.

    The same requirement applies to a netting set that is subject to a 
variation margin agreement under which the counterparty is not required 
to post variation margin. For such a netting set, C also includes the 
negative amount of the variation margin that the banking organization 
posted to the counterparty (thus increasing replacement cost).
    For netting sets subject to a variation margin agreement under 
which the counterparty must post variation margin, the replacement cost 
formula is provided under Sec.  _.132(c)(6)(i) of the final rule and is 
represented as follows:

replacement cost = max{V-C; VMT + MTA-NICA; 0{time} ,

Where:

V is the fair values (after excluding any valuation adjustments) of 
the derivative contracts within the netting set;

[[Page 4376]]

C is the sum of the net independent collateral amount and the 
variation margin amount applicable to such derivative contracts;
VMT is the variation margin threshold applicable to the derivative 
contracts within the netting set; and
MTA is the minimum transfer amount applicable to the derivative 
contracts within the netting set.
NICA is the net independent collateral amount applicable to such 
derivative contracts.

    For a netting set that is subject to multiple variation margin 
agreements, or a hybrid netting set, a banking organization must 
determine replacement cost using the methodology described in Sec.  
_.132(c)(11)(i) of the final rule. Under this paragraph, a banking 
organization must use the standard replacement cost formula (described 
in Sec.  _.132(c)(6)(i) for a netting set subject to a variation margin 
agreement), except that the variation margin threshold equals the sum 
of the variation margin thresholds of all the variation margin 
agreements within the netting set and the minimum transfer amount 
equals the sum of the minimum transfer amounts of all the variation 
margin agreements within the netting set.
    For multiple netting sets subject to a single variation margin 
agreement, a banking organization must assign a single replacement cost 
to the multiple netting sets according to the following formula, as 
provided under Sec.  _.132(c)(10)(i) of the final rule:

Replacement Cost = max{[Sigma]NS max{VNS; 0{time} -max{CMA; 0{time} ; 
0{time}  + max{[Sigma]NS min{VNS; 0{time} -min{CMA; 0{time} ; 0{time} ,

Where:

NS is each netting set subject to the variation margin agreement MA;
VNS is the sum of the fair values (after excluding any 
valuation adjustments) of the derivative contracts within the 
netting set NS; and
CMA is the sum of the net independent collateral amount 
and the variation margin amount applicable to the derivative 
contracts within the netting sets subject to the single variation 
margin agreement.

    The component max{[Sigma]NS max{VNS; 0{time} -max{CMA; 0{time} ; 
0{time}  reflects the exposure amount produced by netting sets that 
have current positive market value. Variation margin and independent 
collateral collected from the counterparty to the transaction can 
offset the current positive market value of these netting sets (i.e., 
this component contributes to replacement cost only in instances when 
CMA is positive). However, netting sets that have current 
negative market value are not allowed to offset the exposure amount. 
The component max{[Sigma]NS min{VNS; 0{time} -min{CMA; 0{time} ; 
0{time}  reflects the exposure amount produced when the banking 
organization posts variation margin and independent collateral to its 
counterparty (i.e., this component contributes to replacement cost only 
in instances when CMA is negative).

D. Potential Future Exposure

    Under the proposal, the PFE for a netting set would have equaled 
the product of the PFE multiplier and the aggregated amount. To 
determine the aggregated amount, a banking organization would have been 
required to determine the hedging set amounts for the derivative 
contracts within a netting set, where a hedging set is comprised of 
derivative contracts that share similar risk factors based on asset 
class (i.e., interest rate, exchange rate, credit, equity, and 
commodity). The aggregated amount would have equaled the sum of all 
hedging set amounts within a netting set.
    Under the proposal, a banking organization would have used a two-
step process to determine the hedging set amount for an asset class. 
First, a banking organization would have determined the composition of 
a hedging set using the asset class definitions set forth in the 
proposal. Second, the banking organization would have determined 
hedging set amount using asset class specific formulas. The hedging set 
amount formulas require a banking organization to determine an adjusted 
derivative contract amount for each derivative contract, and to 
aggregate those amounts to arrive at the hedging set amount for an 
asset class.\77\
---------------------------------------------------------------------------

    \77\ Section III.D.1. of this SUPPLEMENTARY INFORMATION 
discusses the methodology for determining the composition of a 
hedging set using the asset class distinctions set forth in the 
final rule. Section III.D.2. of this SUPPLEMENTARY INFORMATION 
discusses the methodology for determining the adjusted derivative 
contract amount for each derivative contract. Section III.D.3. of 
this SUPPLEMENTARY INFORMATION discusses the PFE multiplier. Section 
III.D.4. of this SUPPLEMENTARY INFORMATION discusses the PFE 
calculation for nonstandard margin agreements.
---------------------------------------------------------------------------

    The final rule adopts the formula for determining PFE as proposed. 
Under Sec.  _.132(c)(7) of the final rule, the PFE of a netting set 
equals the product of the PFE multiplier and the aggregated amount. The 
final rule defines the aggregated amount as the sum of all hedging set 
amounts within the netting set. This formula is represented in the 
final rule as follows:

PFE = PFE multiplier * aggregated amount,

    Where aggregated amount is the sum of each hedging set amount 
within the netting set.
1. Hedging Set Amounts
    Under the proposal, a banking organization would have determined 
the hedging set amount by asset class. To specify each asset class, the 
proposal would have maintained the existing definitions in the capital 
rule for interest rate, exchange rate, credit, equity, and commodity 
derivative contracts. The proposal would have provided hedging set 
definitions for each asset class and sought comment on an alternative 
approach for the definition and treatment of exchange rate derivative 
contracts to recognize the economic relationships of exchange rate 
chains (i.e., when more than one currency pair can offset the risk of 
another). For example, a Yen/Dollar forward contract and a Dollar/Euro 
forward contract, taken together, may be economically equivalent, with 
properly set notional amounts, to a Yen/Euro forward contract when they 
are subject to the same QMNA. The proposal also would have included 
separate treatments for volatility derivative contracts and basis 
derivative contracts.
    Some commenters recommended that the agencies revise the 
definitions for interest rate, exchange rate, equity, and commodity 
derivative contracts for SA-CCR. In particular, the commenters noted 
that there could be instances in which the existing definitions in the 
capital rule are not aligned with the primary risk factor for a 
derivative contract, and therefore would differ from the 
classifications used under SA-CCR. To address this concern, commenters 
requested allowing banking organizations to use the primary risk factor 
for the derivative contract instead of one based on the asset class 
definitions set forth in the proposal.
    The final rule maintains the definitions of interest rate, exchange 
rate, equity, and commodity derivative contracts, as the definitions 
are largely aligned with existing derivative products and market 
practices. In addition to being sufficiently broad to capture the 
various types of derivative contracts, the existing asset class 
definitions are well-established, well-understood, and generally have 
functioned as intended in the capital rule. The final rule preserves 
the ability of the primary Federal regulator to address derivative 
contracts with multiple risk factors by requiring them to be included 
in multiple hedging sets under Sec.  _.132(c)(2)(iii)(H).\78\
---------------------------------------------------------------------------

    \78\ The Board is the primary Federal regulator for bank holding 
companies, savings and loan holding companies, intermediate holding 
companies of foreign banks, and state member banks; the OCC is the 
primary Federal regulator for all national banks and Federal savings 
associations; and the FDIC is the primary Federal regulatory for all 
state nonmember banks and savings associations.

---------------------------------------------------------------------------

[[Page 4377]]

    Some commenters supported the alternative treatment for recognizing 
the economic relationships of exchange rate chains described in the 
proposal, but only if modified to address any potential overstatement 
in the exposure amounts produced when creating separate hedging sets 
for each foreign currency. The agencies believe that the alternative 
treatment described in the proposal, if modified to incorporate 
correlation parameters as suggested by commenters, would add a level of 
complexity to the alternative treatment that would make it 
inappropriate for use in a standardized framework that is intended for 
potential implementation by all banking organizations. The agencies 
further believe that the alternative treatment described in the 
proposal, if modified to require the maximum of long or short risk 
positions, would not add meaningful risk sensitivity by not taking into 
account the correlations between currency risk factors. Therefore, the 
agencies are adopting as final the asset class and hedging set 
definitions as proposed.
    To determine each hedging set amount, a banking organization first 
must group into separate hedging sets derivative contracts that share 
similar risk factors based on the following asset classes: Interest 
rate, exchange rate, credit, equity, and commodity. Basis derivative 
contracts and volatility derivative contracts require separate hedging 
sets. A banking organization then must determine each hedging set 
amount using asset-class specific formulas that allow for full or 
partial offsetting. If the risk of a derivative contract materially 
depends on more than one risk factor, whether interest rate, exchange 
rate, credit, equity, or commodity risk factor, a banking 
organization's primary Federal regulator may require the banking 
organization to include the derivative contract in each appropriate 
hedging set. Under the final rule, the hedging set amount of a hedging 
set composed of a single derivative contract equals the absolute value 
of the adjusted derivative contract amount of the derivative contract.
    Section _.132(c)(2)(iii) of the final rule provides the respective 
hedging set definitions. As noted, an exchange rate hedging set means 
all exchange rate derivative contracts within a netting set that 
reference the same currency pair. Thus, there could be as many exchange 
rate hedging sets within a netting set as distinct currency pairs 
referenced by the exchange rate derivative contracts. An interest rate 
hedging set means all interest rate derivative contracts within a 
netting set that reference the same reference currency. Thus, there 
could be as many interest rate hedging sets in a netting set as 
distinct currencies referenced by the interest rate derivative 
contracts in the netting set. A credit hedging set would mean all 
credit derivative contracts within a netting set. Similarly, an equity 
hedging set means all equity derivative contracts within a netting set. 
Consequently, there could be at most one equity hedging set and one 
credit hedging set within a netting set. A commodity hedging set means 
all commodity derivative contracts within a netting set that reference 
one of the following commodity categories: Energy, metal, agricultural, 
or other commodities. Therefore, there could be no more than four 
commodity derivative contract hedging sets within a netting set.
    Consistent with the proposal, the final rule sets forth separate 
treatments for volatility derivative contracts and basis derivative 
contracts. A basis derivative contract is a non-foreign exchange 
derivative contract (i.e., the contract is denominated in a single 
currency) in which the cash flows of the derivative contract depend on 
the difference between two risk factors that are attributable solely to 
one of the following derivative asset classes: Interest rate, credit, 
equity, or commodity. A basis derivative contract hedging set means all 
basis derivative contracts within a netting set that reference the same 
pair of risk factors and are denominated in the same currency. In 
contrast, a volatility derivative contract means a derivative contract 
in which the payoff of the derivative contract explicitly depends on a 
measure of volatility for the underlying risk factor of the derivative 
contract. Examples of volatility derivative contracts include variance 
and volatility swaps and options on realized or implied volatility. A 
volatility derivative contract hedging set means all volatility 
derivative contracts within a netting set that reference one of 
interest rate, exchange rate, credit, equity, or commodity risk 
factors, separated according to the requirements under Sec.  
_.132(c)(2)(iii)(A)-(E) of the final rule.
a. Interest Rate Derivative Contracts
    Under the proposal, the hedging set amount for a hedging set of 
interest rate derivative contracts would have recognized that interest 
rate derivative contracts with close tenors (i.e., the amount of time 
remaining before the end date of the derivative contract) are generally 
highly correlated, and thus would have provided a greater offset 
relative to interest rate derivative contracts that do not have close 
tenors. In particular, the proposed formula for determining the hedging 
set amount for interest rate derivative contracts would have permitted 
full offsetting within a tenor category and partial offsetting across 
tenor categories, with tenor categories of less than one year, between 
one and five years, and more than five years. The proposal would have 
applied a correlation factor of 70 percent across adjacent tenor 
categories and a correlation factor of 30 percent across nonadjacent 
tenor categories. The tenor of a derivative contract would have been 
based on the period between the present date and the end date of the 
derivative contract, where end date would have meant the last date of 
the period referenced by the derivative contract, or if the derivative 
contract references another instrument, the period referenced by the 
underlying instrument.
    Some commenters asked the agencies to allow banking organizations 
to recognize interest rate derivative contracts within the same QMNA as 
belonging to the same interest rate hedging set, even if such 
derivative contracts reference different currencies. According to the 
commenters, such an approach would allow banking organizations to 
recognize the diversification benefits of multi-currency interest rate 
derivative portfolios. Some of these commenters also suggested 
potential ways to implement this approach. Under one approach, a 
banking organization would calculate the maximum exposure for the 
interest rate derivative contracts within the QMNA under two scenarios 
using a single-factor model. The first scenario would receive a 
correlation factor of zero percent across interest rate exposures in 
different currencies, while the second scenario would receive a 
correlation factor of 70 percent. The former scenario would produce the 
largest amount for portfolios balanced across net short and net long 
currency exposures, while the latter scenario would produce the largest 
amount for portfolios that primarily consist of net long or net short 
currency positions. The second approach would use a single-factor model 
to aggregate interest rate derivative contracts per currency type to 
recognize correlations across currencies. Alternatively, other 
commenters stated that yield curve correlations across major currencies 
could be used to establish correlation

[[Page 4378]]

factors for interest rate derivative contracts that reference different 
currencies. These commenters noted that the Basel Committee's standard 
on minimum capital requirements for market risk incorporates a 
correlation parameter to reflect diversification benefits across multi-
currency interest rate portfolios.\79\ These commenters also stated 
that studies regarding the Basel Committee standard suggest that, by 
not recognizing any hedging or diversification benefits across 
currencies, the proposed method to calculate the hedging set amount for 
interest rate derivatives under SA-CCR is overly conservative. Other 
commenters criticized the proposal as not providing a sufficient 
justification for the requirement that interest rate hedging sets must 
be settled in the same currency to be included within the same hedging 
set, in contrast to the proposed treatment for credit, commodity, and 
equity derivative contracts.
---------------------------------------------------------------------------

    \79\ See ``Minimum capital requirements for market risk,'' Basel 
Committee on Banking Supervision (January 2019, rev. February 2019), 
https://www.bis.org/bcbs/publ/d457.pdf.
---------------------------------------------------------------------------

    The fact that a set of derivative contracts are subject to the same 
QMNA is not determinative of whether hedging benefits across derivative 
contracts actually exist. Interest rates in different currencies can 
move in different directions, rendering correlations unstable. In 
addition, adopting the commenters' recommendations could add 
significant complexity to the final rule. The agencies therefore are 
adopting as final the proposed treatment for determining the hedging 
set amount of interest rate derivative contracts. Under Sec.  
_.132(c)(8)(i) of the final rule, a banking organization must calculate 
the hedging set amount for interest rate derivative contracts according 
to the following formula:
[GRAPHIC] [TIFF OMITTED] TR24JA20.002


Where:

AddOnTB1IR equals the sum of the adjusted derivative 
contract amounts within the hedging set with an end date of less 
than one year from the present date;
AddOnTB2IR equals the sum of the adjusted derivative 
contract amounts within the hedging set with an end date of one to 
five years from the present date; and
AddOnTB3IR equals the sum of the adjusted derivative 
contract amounts within the hedging set with an end date of more 
than five years from the present date.

    Consistent with the proposal, the final rule also includes a 
simpler formula that does not provide an offset across tenor 
categories. Under this approach, the hedging set amount for interest 
rate derivative contracts equals the sum of the absolute amounts of 
each tenor category, which is the sum of the adjusted derivative 
contract amounts within each respective tenor category. The simpler 
formula always results in a more conservative measure of the hedging 
set amount for interest rate derivative contracts of different tenor 
categories, but may be less burdensome for banking organizations with 
smaller interest rate derivative contract portfolios. A banking 
organization may use this simpler formula for some or all of its 
interest rate derivative contracts.
b. Exchange Rate Derivative Contracts
    Exchange rate derivative contracts that reference the same currency 
pair generally are driven by the same market factor (i.e., the exchange 
spot rate between these currencies) and thus are highly correlated. 
Therefore, under the proposal, the formula for determining the hedging 
set amount for exchange rate derivative contracts would have allowed 
for full offsetting within the exchange rate derivative contract 
hedging set. The agencies did not receive comment regarding the formula 
for determining the hedging set amount for exchange rate derivative 
contracts, and are adopting it as proposed. Under Sec.  _.132(c)(8)(ii) 
of the final rule, the hedging set amount for exchange rate derivative 
contracts equals the absolute value of the sum of the adjusted 
derivative contract amounts within the hedging set.
c. Credit Derivative Contracts and Equity Derivative Contracts
    Under the proposal, a banking organization would have used the same 
formula to determine the hedging set amount for both its credit 
derivative contracts and equity derivative contracts. The formula would 
allow full offsetting for credit or equity contracts that reference the 
same entity, and partial offsetting when aggregating across distinct 
reference entities. In addition, the proposal would have provided 
supervisory correlation parameters for credit derivative contracts and 
equity derivative contracts based on whether the derivative contract 
referenced a single-name entity or an index.
    A single-name derivative would have received a correlation factor 
of 50 percent, while an index derivative contract would have received a 
correlation factor of 80 percent to reflect partial diversification of 
idiosyncratic risk within an index. As noted in the proposal, the 
pairwise correlation between two entities is the product of the 
corresponding correlation factors, so that the pairwise correlation 
between two single-name derivatives is 25 percent, between one single-
name and one index derivative is 40 percent, and between two index 
derivatives is 64 percent. The application of a higher correlation 
factor does not necessarily result in a higher exposure amount because 
the proposal generally would have yielded a lower exposure amount for 
balanced portfolios relative to directional portfolios.
    Several commenters asked the agencies to allow banking 
organizations to decompose indices within credit and equity asset 
classes to reflect the exposure of highly correlated net long and short 
positions within an index. Under Sec.  _.132(c)(5)(vi) of the final 
rule, a banking organization may elect to decompose indices within 
credit and equity asset classes, such that a banking organization would 
treat each component of the index as a separate single-name derivative 
contract. Thus, under this election, a banking organization would apply 
the SA-CCR methodology to each component of the index as if it were a 
separate single-name derivative contract instead of applying the SA-CCR 
methodology to

[[Page 4379]]

the index derivative contract. This approach provides enhanced risk 
sensitivity to the SA-CCR framework by allowing for recognition of the 
hedging benefits provided by the components of an index. In addition, 
this approach is similar to other aspects of the capital rule.\80\ The 
agencies will monitor the application of the decomposition approach, 
including the correlation assumptions between an index and its 
components, to ensure that the approach is functioning as intended.
---------------------------------------------------------------------------

    \80\ See e.g., 12 CFR 3.53 (OCC); 12 CFR 217.53 (Board); and 12 
CFR 324.53 (FDIC).
---------------------------------------------------------------------------

    Under the final rule, a banking organization must determine the 
hedging set amount for its credit and equity derivative contracts set 
forth in Sec.  _.132(c)(8)(iii) of the final rule, as follows:
[GRAPHIC] [TIFF OMITTED] TR24JA20.003

Where:

k is each reference entity within the hedging set;
K is the number of reference entities within the hedging set;
AddOn(Refk) equals the sum of the adjusted derivative contract 
amounts for all derivative contracts within the hedging set that 
reference reference entity k; and
[rho]k equals the applicable supervisory correlation factor, as 
provided in Table 2.
d. Commodity Derivative Contracts
    The proposal would have required a banking organization to 
determine the hedging set amount for commodity derivative contracts 
based on the following four commodity categories: Energy, metal, 
agricultural and other. The proposal would have permitted full 
offsetting for all derivative contracts within the same commodity 
category (i.e., within a hedging set) that reference the same commodity 
type, and partial offsetting for all derivative contracts within the 
same commodity category that reference different commodity types.
    Under the proposal, a commodity type would have referred to a 
specific commodity within one of the four commodity categories. 
Additionally, the proposal would not have provided separate supervisory 
factors for different commodity types within the energy commodity 
category.\81\ For example, under the proposal, a hedging set could have 
been composed of crude oil derivative contracts and electricity 
derivative contracts, with each subject to the same supervisory factor. 
A banking organization would have been able to fully offset all crude 
oil derivative contracts against each other and all electricity 
derivative contracts against each other (as they reference the same 
commodity type). In addition, a banking organization would not have 
been able to offset commodity derivative contracts that are included in 
different commodity categories (i.e., a forward contract on crude oil 
cannot hedge a forward contract on corn).
---------------------------------------------------------------------------

    \81\ See section III.D.2.b. of this SUPPLEMENTARY INFORMATION 
for a more detailed discussion on supervisory factors under the 
final rule.
---------------------------------------------------------------------------

    Several commenters asked the agencies to clarify the offsetting 
treatment among the different types of contracts within the energy 
category (e.g., electricity and oil/gas derivative contracts). Some 
commenters asked the agencies to allow banking organizations to 
decompose derivative contracts that reference commodity indices, such 
that a banking organization would treat each component of the index as 
a separate single-name derivative contract.
    Consistent with the proposal, the final rule permits full 
offsetting for all derivative contracts within a hedging set that 
reference the same commodity type, and partial offsetting for all 
derivative contracts within a hedging set that reference different 
commodity types within the same commodity category.\82\ This treatment 
applies consistently to each of the four commodity categories, 
including energy. For example, electricity derivative contracts within 
the same hedging set may fully offset each other, whereas electricity 
derivative contracts and non-electricity derivate contracts (e.g., oil 
derivative contracts) within the same hedging set may only partially 
offset each other because they are different commodity types within the 
same commodity category.
---------------------------------------------------------------------------

    \82\ The final rule provides separate supervisory factors for 
electricity derivative contracts and other types of commodity 
derivative contracts within the energy category as discussed further 
in section III.D.2.b.iii. of this SUPPLEMENTARY INFORMATION.
---------------------------------------------------------------------------

    In an attempt to appropriately balance risk sensitivity with 
operational burden, consistent with the proposal, the final rule allows 
banking organizations to recognize commodity types without regard to 
characteristics such as location or quality. For example, a banking 
organization may recognize crude oil as a commodity type, and would not 
need to distinguish further between West Texas Intermediate and Saudi 
Light crude oil.
    In response to comments, Sec.  _.132(c)(5)(vi) of the final rule 
allows a banking organization to elect to decompose commodity indices, 
such that a banking organization would treat each component of the 
index as a separate, single-name derivative contract. Thus, under this 
election, a banking organization would apply the SA-CCR methodology to 
each component of the index as if it were a separate, single-name 
derivative contract, instead of applying the SA-CCR methodology to the 
index derivative contract. This approach provides enhanced risk 
sensitivity to the SA-CCR framework by allowing for better recognition 
of hedging benefits provided by the components of an index. In 
addition, this approach is similar to other aspects of the capital 
rule.\83\
---------------------------------------------------------------------------

    \83\ See supra note 80.
---------------------------------------------------------------------------

    The agencies recognize that specifying separate commodity types is 
operationally difficult; indeed, it is likely infeasible to 
sufficiently specify all relevant distinctions between commodity types 
in order to capture all basis risk. Therefore, the agencies will 
monitor the commodity-type distinctions made within the industry for 
purposes of both the full offset treatment for commodity derivative 
contracts of the same type and the decomposition approach for commodity 
indices, to ensure that they are being applied and functioning as 
intended.
    Consistent with the proposal, a banking organization must assign a 
derivative contract to the ``other'' commodity category if the 
derivative contract does not meet the criteria for the energy, metal or 
agricultural commodity categories.
    The hedging set amount for commodity derivative contracts would

[[Page 4380]]

be determined under Sec.  _.132(c)(8)(iv) of the final rule, as 
follows:

[GRAPHIC] [TIFF OMITTED] TR24JA20.004

Where:

k is each commodity type within the hedging set;
K is the number of commodity types within the hedging set;
AddOn(Typek) equals the sum of the adjusted derivative 
contract amounts for all derivative contracts within the hedging set 
that reference commodity type k; and
[rho] equals the applicable supervisory correlation factor, as 
provided in Table 2 of the preamble.
2. Adjusted Derivative Contract Amount
    Under the proposal, the adjusted derivative contract amount would 
have represented a conservative estimate of effective expected positive 
exposure (EEPE) \84\ for a netting set consisting of a single 
derivative contract, assuming zero market value and zero collateral, 
that is either positive (if a long position) or negative (if a short 
position). A banking organization would have calculated the adjusted 
derivative contract amount as a product of four components: The 
adjusted notional amount, the applicable supervisory factor, the 
applicable supervisory delta adjustment, and the applicable maturity 
factor. The adjusted derivative contact amount for each asset class 
would have been aggregated under the hedging set amount formulas for 
each asset class, as described above. The agencies received no comments 
on this aspect of the proposal, and are finalizing the formula for 
determining the adjusted derivative contract amount as proposed under 
Sec.  _.132(c)(9) of the final rule.
---------------------------------------------------------------------------

    \84\ See supra note 10.
---------------------------------------------------------------------------

    The formula to determine the adjusted derivative contract amount is 
represented as follows:

adjusted derivative contract amount = di * [delta]i * MFi * SFi.

Where:

di is the adjusted notional amount;
[delta]i is the applicable supervisory delta adjustment;
MFi is the applicable maturity factor; and
SFi is the applicable supervisory factor.

    The adjusted notional amount accounts for the size of the 
derivative contract and reflects the attributes of the most common 
derivative contracts in each asset class. The supervisory factor 
converts the adjusted notional amount of the derivative contract into 
an EEPE based on the measured volatility specific to each asset class 
over a one-year horizon.\85\ The supervisory delta adjustment accounts 
for the sensitivity of a derivative contract (scaled to unit size) to 
the underlying primary risk factor, including the correct sign 
(positive or negative) to account for the direction of the derivative 
contract amount relative to the primary risk factor.\86\ Finally, the 
maturity factor scales down, if necessary, the derivative contract 
amount from the standard one-year horizon used for supervisory factor 
calibration to the risk horizon relevant for a given contract.
---------------------------------------------------------------------------

    \85\ Specifically, the supervisory factors are intended to 
reflect the EEPE of a single at-the-money linear trade of unit size, 
zero market value and one-year maturity referencing a given risk 
factor in the absence of collateral. See supra note 10.
    \86\ Sensitivity of a derivative contract to a risk factor is 
the ratio of the change in the market value of the derivative 
contract caused by a small change in the risk factor to the value of 
the change in the risk factor. In a linear derivative contract, the 
payoff of the derivative contract moves at a constant rate with the 
change in the value of the underlying risk factor. In a nonlinear 
contract, the payoff of the derivative contract does not move at a 
constant rate with the change in the value of the underlying risk 
factor. The sensitivity is positive if the derivative contract is 
long the risk factor and negative if the derivative contract is 
short the risk factor.
---------------------------------------------------------------------------

a. Adjusted Notional Amount
i. Interest Rate and Credit Derivative Contracts
    Under the proposal, a banking organization would have applied the 
same formula to interest rate derivative contracts and credit 
derivative contracts to arrive at the adjusted notional amount. For 
such contracts, the adjusted notional amount would have equaled the 
product of the notional amount of the derivative contract, as measured 
in U.S. dollars, using the exchange rate on the date of the 
calculation, and the supervisory duration. The supervisory duration 
would have incorporated measures of the number of business days from 
the present day until the start date for the derivative contract (S), 
and the number of business days from the present day until the end date 
for the derivative contract (E).
    Some commenters argued that the standard notional definition would 
not produce reasonably accurate exposure estimates of a banking 
organization's closeout risk for all types of derivative contracts. 
These commenters recommended allowing banking organizations to use 
internal methodologies to determine the adjusted notional amount for 
derivative contracts that are not specifically covered under the 
formulas and methodologies set forth in the proposal.
    The final rule maintains the formulas and methodologies for 
determining the adjusted notional amount for interest rate and credit 
derivative contracts, as generally one of these will be applicable for 
most derivative contracts. However, the agencies recognize that such 
approaches may not be applicable to all types of derivative contracts, 
and that a different approach may be necessary to determine the 
adjusted notional amount of a derivative contract. In such a case, a 
banking organization must consult with its primary Federal regulator 
prior to using an alternative approach to the formulas or methodologies 
set forth in the final rule.
    Some commenters suggested revising the proposal to provide a 
separate measure of S for fixed-to-floating interest rate derivative 
contracts where the floating rate is determined at the beginning of the 
reset period and paid at the end, defined as the time period until the 
earliest reset date, measured in years.
    According to the commenters, the proposal could overestimate the 
duration for such derivative contracts, as it would include the time 
period for which the floating rate (and, therefore, the floating leg 
payment) is captured in the supervisory duration. The commenters also 
noted that such

[[Page 4381]]

treatment could significantly affect the adjusted notional amount for a 
short-dated interest rate derivative portfolio.
    Other commenters recommended changes to the measure of S for basis 
derivative contracts, for which the floating rates on the reference 
exposure are set at the beginning of the payment period. Some of these 
commenters recommended measuring S as the period (in years) as the 
earliest reset date of the two floating-rate components of the 
contract, if the reset dates are different.
    The treatment recommended by the commenters cannot be made 
applicable to all interest rate derivatives; for example, it would not 
be appropriate for in arrears swaps, in which the rate is set at the 
end of the reset period instead of the beginning, and for forward rate 
agreements. In addition, adopting the commenters' recommendations could 
add significant complexity to the final rule because it would require 
additional parameters in the adjusted notional amount formula that 
would be used only in certain circumstances. Such an approach would 
create additional burden for banking organizations that adopt SA-CCR 
and could adversely affect the agencies' ability to use SA-CCR to 
assess comparability across banking organizations. The agencies 
therefore are adopting as final the proposed treatment for determining 
the adjusted notional amount of interest rate and credit derivative 
contracts.
    Some commenters requested changes to address forward-settling 
mortgage-backed securities traded in the to-be-announced (TBA) market. 
Specifically, these commenters asked the agencies to recalibrate the 
adjusted notional amount for TBA derivative contracts to account for 
the term of the mortgage loans underlying the securities. Other 
commenters recommended measuring S for TBA derivative contracts as the 
time-weighted average term of the mortgages underlying the securities. 
In response to commenter concerns, the agencies are clarifying that for 
an interest rate derivative contract or credit derivative contract that 
is a variable notional swap, including mortgage-backed securities 
traded in the TBA market, the notional amount is equal to the time-
weighted average of the contractual notional amounts of such a swap 
over the remaining life of the swap.
    Other commenters recommended measuring the adjusted notional amount 
for basis derivative contracts as the product of the absolute value of 
the spread between the two underlying risk factors (positive or 
negative) and the number of units. According to these commenters, such 
an approach would better reflect the risk of such transactions because 
SA-CCR requires the use of floating notional values, and the notional 
value may change after execution based on increases or decreases in the 
spread. The commenters also argued that such an approach would be 
consistent with guidance released by the CFTC regarding the notional 
amount for locational basis derivative contracts.\87\ The final rule 
does not incorporate the commenters' suggestion, as the purpose of the 
proposed treatment is to obtain the absolute volatility of the contract 
price, which is related to each risk factor rather than the spread.
---------------------------------------------------------------------------

    \87\ See CFTC, Division of Swap Dealer and Intermediary 
Oversight, FAQs About Swap Entities (Oct. 12, 2012), at 1.
---------------------------------------------------------------------------

    The final rule adopts without change the proposed treatment for 
determining the adjusted notional amount for credit and interest rate 
derivative contracts. Under Sec.  _.132(c)(9)(ii)(A) of the final rule, 
the adjusted notional amount for such contracts equals the product of 
the notional amount of the derivative contract, as measured in U.S. 
dollars using the exchange rate on the date of the calculation, and the 
supervisory duration. The formula to determine the supervisory duration 
is as follows:
[GRAPHIC] [TIFF OMITTED] TR24JA20.005

Where:

S is the number of business days from the present day until the 
start date for the derivative contract, or zero if the start date 
has already passed; and
E is the number of business days from the present day until the end 
date for the derivative contract.

    A banking organization must calculate the supervisory duration for 
the period that starts at S and ends at E, where S equals the number of 
business days between the present date and the start date for the 
derivative contract, or zero if the start date has passed, and E equals 
the number of business days from the present date until the end date 
for the derivative contract. The supervisory duration recognizes that 
interest rate derivative contracts and credit derivative contracts with 
a longer tenor have a greater degree of variability than an identical 
derivative contract with a shorter tenor for the same change in the 
underlying risk factor (interest rate or credit spread), and is based 
on the assumption of a continuous stream of equal payments and a 
constant continuously compounded interest rate of 5 percent. The 
exponential function provides discounting for S and E at 5 percent 
continuously compounded. In all cases, the supervisory duration is 
floored at ten business days (or 0.04, based on an average of 250 
business days per year).
    For an interest rate derivative contract or a credit derivative 
contract that is a variable notional swap, the notional amount equals 
the time-weighted average of the contract notional amounts of such a 
swap over the remaining life of the swap. For an interest rate 
derivative contract or a credit derivative contract that is a leveraged 
swap, in which the notional amounts of all legs of the derivative 
contract are divided by a factor and all rates of the derivative 
contract are multiplied by the same factor, the notional amount equals 
the notional amount of an equivalent unleveraged swap.
ii. Exchange Rate Derivative Contracts
    Under the proposal, the adjusted notional amount for an exchange 
rate derivative contract would have equaled the notional amount of the 
non-U.S. denominated currency leg of the derivative contract, as 
measured in U.S. dollars using the exchange rate on the date of the 
calculation. In general, the non-U.S. dollar denominated currency leg 
is the source of exchange rate volatility. If both legs of the exchange 
rate derivative contract are denominated in currencies other than U.S. 
dollars, the adjusted notional amount of the derivative contract would 
have been the largest leg of the derivative contract, measured in U.S. 
dollars. For an exchange rate derivative contract with multiple 
exchanges of principal, the notional amount would have equaled

[[Page 4382]]

the notional amount of the derivative contract multiplied by the number 
of exchanges of principal under the derivative contract. The agencies 
received no comments on the proposed adjusted notional amount for 
exchange rate derivative contracts, and are adopting it as final under 
Sec.  _.132(c)(9)(ii)(B) of the final rule.
iii. Equity and Commodity Derivative Contracts
    Under the proposal, a banking organization would have applied the 
same single-factor formula to equity derivative contracts and commodity 
derivative contracts. For such contracts, the adjusted notional amount 
would have equaled the product of the fair value of one unit of the 
reference instrument underlying the derivative contract and the number 
of such units referenced by the derivative contract. By design, the 
proposed treatment would have reflected the current price of the 
underlying reference instrument. For example, if a banking organization 
has a derivative contract that references 15,000 pounds of frozen 
concentrated orange juice currently priced at $0.0005 a pound then the 
adjusted notional amount would be $7.50. For an equity derivative 
contract or a commodity derivative contract that is a volatility 
derivative contract, a banking organization would have been required to 
replace the unit price with the underlying volatility referenced by the 
volatility derivative contract and replace the number of units with the 
notional amount of the volatility derivative contract. By design, the 
proposed treatment would have reflected that the payoff of a volatility 
derivative contract generally is determined based on a notional amount 
and the realized or implied volatility (or variance) referenced by the 
derivative contract and not necessarily the unit price of the 
underlying reference instrument. The agencies received no comments on 
the proposed adjusted notional amount for equity and commodity 
derivative contracts, including instances in which such a contract is a 
volatility derivative contract, and are adopting it without change 
under Sec.  _.132(c)(9)(ii)(C) of the final rule.
b. Supervisory Factor
i. Credit Derivative Contracts
    In contrast to the Basel Committee standard, the proposal would not 
have provided for the use of credit ratings to determine the 
supervisory factor for credit derivative contracts due to section 939A 
of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-
Frank Act), which prohibits the use of credit ratings in Federal 
regulations.\88\ As an alternative, the proposal would have introduced 
an approach that satisfies section 939A of the Dodd-Frank Act while 
allowing for a level of granularity among the supervisory factors 
applicable to single-name credit derivatives that would have been 
generally consistent with the Basel Committee standard.\89\ Under the 
proposal for single-name credit derivative contracts, investment grade 
derivative contracts would have received a supervisory factor of 0.5 
percent, speculative grade derivative contracts would have received a 
supervisory factor of 1.3 percent, and sub-speculative grade derivative 
contracts would have received a supervisory factor of 6.0 percent. For 
credit derivative contracts that reference an index, investment grade 
derivative contracts would have received 0.38 percent and speculative 
grade derivative contracts would have received 1.06 percent. The 
proposal would have revised the capital rule to include definitions for 
speculative grade and sub-speculative grade (the capital rule already 
includes a definition for investment grade). The agencies received 
several comments on the supervisory factors for credit derivative 
contracts, but no comments on the proposed definitions of speculative 
grade and sub-speculative grade.
---------------------------------------------------------------------------

    \88\ See Public Law 111-203, 124 Stat. 1376 (2010), section 
939A. This provision is codified as part of the Securities Exchange 
Act of 1934 at 15 U.S.C. 78o-7.
    \89\ Specifically, the supervisory factors in the Basel 
Committee's SA-CCR standard are as follows (in percent): AAA and AA-
0.38, A-0.42; BBB-0.54; BB-1.06; B-1.6; CCC-6.0.
---------------------------------------------------------------------------

    Several commenters encouraged the agencies to reconsider the 
proposed methodology for determining the supervisory factors for 
single-name credit derivative contracts. As an alternative, the 
commenters recommended an approach that maps probability of default 
(PD) bands to the credit rating categories and the corresponding 
supervisory factors set forth in the Basel Committee standard for 
single-name credit derivatives, consistent with the approach used to 
assign a counterparty risk weight under the simple CVA approach in the 
advanced approaches.\90\ According to the commenters, this approach 
would more closely align with the granularity and the supervisory 
factors provided under the Basel Committee standard, while meeting the 
requirements of section 939A of the Dodd-Frank Act. Alternatively, if 
the agencies declined to adopt the PD band-based approach for purposes 
of the final rule, the commenters suggested lowering the proposed 
supervisory factor for investment grade single-name credit derivatives 
from 0.5 percent to 0.46 percent, to eliminate the impact of rounding 
(to the nearest tenth) that was conducted for purposes of the proposal. 
Other commenters suggested aligning the supervisory factor for 
investment grade single-name credit derivatives to the lowest 
supervisory factor under the Basel Committee standard, 0.38 percent, 
based on the view that the most creditworthy issuers in the United 
States are no more prone to default than the most creditworthy issuers 
in other jurisdictions.
---------------------------------------------------------------------------

    \90\ See 12 CFR 3.132(e)(5) (OCC); 12 CFR 217.132(e)(5) (Board); 
and 12 CFR 324.132(e)(5) (FDIC).
---------------------------------------------------------------------------

    SA-CCR is a standardized approach, and the use of PD bands to 
assign supervisory factors to single-name credit derivatives would 
require the use of internal models, which generally are not appropriate 
for a standardized approach that is intended to be implementable by 
banking organizations of all sizes. In addition, providing such 
treatment as an option in SA-CCR could introduce more risk sensitivity 
solely for more sophisticated banking organizations that currently 
determine PD for purposes of the advanced approaches, and potentially 
provide a competitive advantage to such firms and adversely affect the 
use of SA-CCR to assess comparability across banking organizations. In 
addition, lowering the supervisory factor for single-name investment 
grade credit derivatives to 0.38 percent would fail to recognize the 
meaningful differences in the risks captured by the investment grade 
category under the proposal and the final rule, relative to the 
category and supervisory factor that correspond solely to an AAA credit 
rating under the Basel Committee standard. In response to comments, 
however, the final rule applies a 0.46 percent supervisory factor to 
investment grade single-name credit derivative contracts. This change 
will enhance the precision and risk sensitivity of the final rule, 
without introducing undue complexity or materially affecting the amount 
of regulatory capital a banking organization must hold for such 
derivative contracts relative to the proposal.
    Therefore, the final rule adopts the supervisory factors for credit 
derivative contracts, as proposed, with one modification to the 
supervisory factor for investment grade single-name credit derivative 
contracts as described above. In addition, the final rule maintains the 
current definition of investment grade

[[Page 4383]]

in the capital rule, and adopts the proposed definitions for 
``speculative grade'' and ``sub-speculative grade.'' The supervisory 
factors are reflected in Table 2 of this SUPPLEMENTARY INFORMATION.
    The investment grade category generally captures single-name credit 
derivative contracts consistent with the three highest supervisory 
factor categories under the Basel Committee standard. The capital rule 
defines investment grade to mean that the entity to which the banking 
organization is exposed through a loan or security, or the reference 
entity with respect to a credit derivative contract, has adequate 
capacity to meet financial commitments for the projected life of the 
asset or exposure. Such an entity or reference entity has adequate 
capacity to meet financial commitments, as the risk of its default is 
low and the full and timely repayment of principal is expected.\91\
---------------------------------------------------------------------------

    \91\ ``Investment grade'' is defined in Sec.  _.2 of the capital 
rule. See 12 CFR 3.2 (OCC); 12 CFR 217.2 (Board); and 12 CFR 324.2 
(FDIC).
---------------------------------------------------------------------------

    The speculative grade category generally captures single-name 
credit derivative contracts consistent with the next two lower 
supervisory factor categories under the Basel Committee standard. The 
final rule defines the term speculative grade to mean that the 
reference entity has adequate capacity to meet financial commitments in 
the near term, but is vulnerable to adverse economic conditions, such 
that should economic conditions deteriorate, the reference entity would 
present elevated default risk. The sub-speculative grade category 
corresponds to the lowest supervisory factor category under the Basel 
Committee standard, with the term sub-speculative grade defined under 
the final rule to mean that the reference entity depends on favorable 
economic conditions to meet its financial commitments, such that should 
economic conditions deteriorate, the reference entity likely would 
default on its financial commitments. Each of these categories includes 
exposures that perform largely in accordance with the performance 
criteria that define each category under the final rule, and therefore 
result in capital requirements that are broadly equivalent to those 
resulting from application of the supervisory factors under the Basel 
Committee standard.\92\
---------------------------------------------------------------------------

    \92\ An empirical analysis for the supervisory factors applied 
to the investment grade and speculative grade categories is set 
forth in the SUPPLEMENTARY INFORMATION section of the proposal. See 
83 FR 64660, 64675 (December 17, 2018).
---------------------------------------------------------------------------

    The agencies expect that banking organizations would conduct their 
own due diligence to determine the appropriate category for a single-
name credit derivative, in view of the performance criteria in the 
definitions for each category under the final rule. A banking 
organization may consider the credit rating for a single-name credit 
derivative in making that determination as part of a multi-factor 
analysis. In addition, the agencies expect a banking organization to 
have and retain support for its analysis and assignment of the 
respective credit categories.
ii. Equity Derivative Contracts
    Under the proposal, single-name equity derivative contracts would 
have received a supervisory factor of 32 percent and equity derivative 
contracts that reference an index would have received a supervisory 
factor of 20 percent. The agencies received several comments regarding 
the proposed supervisory factors for equity derivative contracts. In 
general, the commenters recommended various approaches to distinguish 
among the risks of single-name equity derivative contracts and thereby 
provide additional granularity in the supervisory factors that 
correspond to such exposures. The approaches offered by the commenters 
would distinguish among (1) investment grade and non-investment grade 
issuers; (2) issuers in advanced and emerging markets; (3) issuers with 
large market capitalizations and those with small market 
capitalizations; and (4) issuers in different industry sectors. Some of 
the approaches suggested by commenters align with the Basel Committee 
market risk standard.\93\ Commenters also suggested various 
permutations of these approaches (e.g., use of sector differentiation 
in combination with a distinction for advanced and emerging markets). 
Some commenters provided analysis suggesting that each of these 
approaches could offer additional granularity and allow for lower 
supervisory factors for investment grade, advanced markets, and large 
cap issuers, relative to the supervisory factors under the proposal and 
the Basel Committee standard. Commenters also suggested incorporating 
one of the above distinctions into the supervisory factors for equity 
indices.
---------------------------------------------------------------------------

    \93\ See supra note 79.
---------------------------------------------------------------------------

    The agencies acknowledge that certain aspects of the proposal could 
be revised to enhance its risk sensitivity; however, any such revisions 
must be balanced against the objectives of simplicity and ensuring 
comparability among banking organizations that implement SA-CCR. 
Attempting to define different categories of market types or allocating 
exposures across the various alternate categories posed by commenters, 
and then calibrating supervisory factors associated with each of those 
sub-categories, would increase the complexity of applying SA-CCR and 
reduce comparability among banking organizations. Further adjustments 
to the supervisory factor for equity derivative contracts to align with 
the revised Basel III market risk standard, as recommended by 
commenters, potentially could be considered if that standard is 
implemented in the United States in a future rulemaking. Therefore, the 
final rule adopts as proposed the supervisory factors for equity 
derivative contracts, as reflected in Table 2 of the final rule.
iii. Commodity Derivative Contracts
    The proposal would have established four commodity categories: 
Energy, metals, agriculture, and other. Energy derivative contracts 
would have received a supervisory factor of 40 percent, whereas 
derivative contracts in the non-energy commodity categories (i.e., 
metal, agricultural, and other) each would have received a supervisory 
factor of 18 percent.
    The agencies received a number of comments on the proposed 
supervisory factors for commodity derivative contracts. Several 
commenters encouraged the agencies to recalibrate the supervisory 
factors for commodity derivative contracts to reflect the market price 
of forward contracts, stating that this would better reflect the actual 
volatility of the commodity derivatives market compared to the market 
price of spot contracts. According to these commenters, such an 
approach would reflect the widespread use of commodity derivative 
contracts in the market, as a way to hedge commodity price risk for 
months or years into the future. As an alternative to this 
recommendation, commenters suggested full alignment with the 
supervisory factors for commodity derivative contracts in the Basel 
Committee standard, which applies a 40 percent supervisory factor to 
electricity derivative contracts and an 18 percent supervisory factor 
to oil/gas derivative contracts, each within the energy category.
    Other commenters expressed concern that the proposed supervisory 
factors for commodity derivative contracts were not sufficiently 
granular. These commenters argued that each of the commodity categories 
set forth in the proposal would include a wide range of commodity types 
that present different levels of risk. As a result, the commenters 
expressed concern that the

[[Page 4384]]

proposal would overstate the amount of capital that must be held for 
certain lower-risk commodities, particularly natural gas and certain 
types of agricultural commodities.\94\ Several commenters expressed 
concern that the proposed supervisory factors for commodity derivative 
contracts would indirectly increase the cost of such contracts for 
commercial end-user counterparties, who may use commodity derivative 
contracts to manage commercial risk.
---------------------------------------------------------------------------

    \94\ See section III.D.1.d. of this SUPPLEMENTARY INFORMATION.
---------------------------------------------------------------------------

    In response to comments, the final rule adopts a separate 
supervisory factor of 18 percent for all energy derivative contracts 
except for electricity derivative contracts, which receive a 
supervisory factor of 40 percent. This treatment enhances the risk 
sensitivity of the supervisory factors for derivative contract types 
within the energy commodity category in a manner that aligns with the 
Basel Committee standard.\95\ The final rule does not revise the other 
supervisory factors proposed for commodity derivatives, or provide for 
more granularity in the supervisory factors. In addition to presenting 
significant challenges and materially increasing the complexity of the 
framework (as noted in section III.D.1.d. of this SUPPLEMENTARY 
INFORMATION), revising the proposal to include additional commodity 
categories for specific commodity types could limit the full offset 
treatment available to commodity types within the same category. 
Recalibrating the supervisory factors for commodity derivative 
contracts to reflect the volatility driven by forward prices also would 
not be appropriate for all commodity derivative contracts because the 
value of short-term derivative contracts--which also are prevalent 
within the market--is driven by spot prices rather than forward prices. 
Moreover, such an approach would materially deviate from the Basel 
Committee standard and could create material inconsistencies in the 
international treatment of derivative contracts across jurisdictions. 
Any such inconsistencies could create regulatory compliance burdens for 
large, internationally active banking organizations required to 
determine capital requirements for derivative contracts under multiple 
regulatory regimes, and could provide incentives for such banking 
organizations to book commodity derivatives in an entity located in the 
jurisdiction that provides for the most favorable treatment from a 
regulatory capital perspective.
---------------------------------------------------------------------------

    \95\ As described in section III.D.1.d. of this SUPPLEMENTARY 
INFORMATION, for purposes of calculating the hedging set amount, the 
final rule permits full offsetting for all derivative contracts 
within a hedging set that reference the same commodity type, and 
partial offsetting for all derivative contracts within a hedging set 
that reference different commodity types within the same commodity 
category.
---------------------------------------------------------------------------

    Other commenters recommended revising the proposal to provide 
separate recognition for derivative contracts that reference commodity 
indices. According to these commenters, diversification across 
different commodities significantly lowers the volatility of a 
diversified index when compared to the undiversified volatilities of 
the index constituents. The final rule does not include a specific 
treatment for commodity indices because they are typically highly 
heterogeneous depending on their compositions and maturities and, as a 
result, a single calibration for such a broad asset class will not 
provide for the risk sensitivity intended by SA-CCR.
    Under the proposal, a banking organization would have been required 
to treat a gold derivative contract as a commodity derivative contract 
rather than an exchange rate derivative contract, and apply a 
supervisory factor of 18 percent. Several commenters argued for 
revising the proposal to recognize gold derivative contracts as a type 
of exchange rate derivative contract. According to the commenters, such 
treatment would be consistent with CEM, IMM, the Basel Committee's 
Basel II accord issued in 2004 (Basel II),\96\ and industry practice. 
The commenters also asserted that, similar to currencies, gold serves 
as a macroeconomic hedge to dynamic market conditions including 
declining equity prices, inflationary pressures, and political crises.
---------------------------------------------------------------------------

    \96\ See ``International Convergence of Capital Measurement and 
Capital Standards: A Revised Framework,'' Basel Committee on Banking 
Supervision (June 2004), https://www.bis.org/publ/bcbs107.pdf.
---------------------------------------------------------------------------

    Based on an analysis of price data for gold, silver, nickel and 
platinum from January 2001 to January 2019, gold exhibits historical 
volatility levels that are generally consistent with those observed for 
other metals, and are nearly identical to the historical volatility 
levels observed for platinum over the same period. Accordingly, 
treating a gold derivative contract as an exchange rate derivative 
contract would significantly understate the risk associated with such 
exposures, notwithstanding their treatment under either Basel II, IMM 
or CEM. Moreover, the supervisory factors under SA-CCR are calibrated 
to volatilities observed in the primary risk factor, and are not based 
on the purpose for which such a derivative contract may be entered 
into. Therefore, consistent with the proposal, under the final rule a 
banking organization must treat a gold derivative contract as a 
commodity derivative contract, with a supervisory factor of 18 percent.
    The final rule adopts the supervisory factors for commodity 
derivative contracts, as proposed, with one modification to the 
supervisory factor for energy derivative contracts that are not 
electricity derivative contracts as discussed above. The supervisory 
factors are reflected in Table 2 of this SUPPLEMENTARY INFORMATION and 
Table 2 to Sec.  _.132 of the final rule.
iv. Interest Rate Derivative Contracts
    Under the proposal, interest rate derivative contracts would have 
received a supervisory factor of 0.5 percent. The agencies did not 
receive comments on this aspect of the proposal, and are adopting it as 
proposed, as reflected in Table 2 of this SUPPLEMENTARY INFORMATION.
v. Exchange Rate Derivative Contracts
    Under the proposal, exchange rate derivative contracts would have 
received a supervisory factor of 4 percent. As noted in the discussion 
on supervisory factors for commodity derivative contracts, several 
commenters supported treating gold derivative contracts as a type of 
exchange rate derivative contract. However, as noted previously, 
treating a gold derivative as an exchange rate derivative contract 
would significantly understate the risk associated with such exposures. 
The agencies are therefore adopting as final the proposal to treat a 
gold derivative contract as a commodity derivative contract. The 
agencies did not receive comments on other aspects of the proposed 
supervisory factors for exchange rate derivative contracts, and are 
adopting them as final, as reflected in Table 2 of this SUPPLEMENTARY 
INFORMATION.
vi. Volatility Derivative Contracts and Basis Derivative Contracts
    For volatility derivative contracts, the proposal would have 
required a banking organization to multiply the applicable supervisory 
factor based on the asset class related to the volatility measure by a 
factor of five. This treatment would have recognized that volatility 
derivative contracts are inherently subject to more price volatility 
than the underlying asset classes they reference.
    For basis derivative contracts, the proposal would have required a 
banking

[[Page 4385]]

organization to multiply the applicable supervisory factor based on the 
asset class related to the basis measure by a factor of one half. This 
treatment would have reflected that the volatility of a basis 
derivative contract is based on the difference in volatilities of 
highly correlated risk factors, which would have resulted in a lower 
volatility than a derivative contract that is not a basis derivative 
contract. The agencies did not receive comments on the proposed 
supervisory factors for volatility derivative contracts and basis 
derivative contracts, and the final rule adopts this aspect of the 
proposal without change.

             Table 2--Supervisory Option Volatility and Supervisory Factors for Derivative Contracts
----------------------------------------------------------------------------------------------------------------
                                                                    Supervisory     Supervisory
                                                                      option        correlation     Supervisory
         Asset class               Category            Type         volatility        factor         factor 1
                                                                     (percent)       (percent)       (percent)
----------------------------------------------------------------------------------------------------------------
Interest rate................  N/A.............  N/A............              50             N/A            0.50
Exchange rate................  N/A.............  N/A............              15             N/A             4.0
Credit, single name..........  Investment grade  N/A............             100              50            0.46
                               Speculative       N/A............             100              50             1.3
                                grade.
                               Sub-speculative   N/A............             100              50             6.0
                                grade.
Credit, index................  Investment Grade  N/A............              80              80            0.38
                               Speculative       N/A............              80              80            1.06
                                Grade.
                               N/A.............  N/A............             120              50              32
Equity, index................  N/A.............  N/A............              75              80              20
Commodity....................  Energy..........  Electricity....             150              40              40
                                                 Other..........              70              40              18
                               Metals..........  N/A............              70              40              18
                               Agricultural....  N/A............              70              40              18
                               Other...........  N/A............              70              40              18
----------------------------------------------------------------------------------------------------------------
\1\ The applicable supervisory factor for basis derivative contract hedging sets is equal to one-half of the
  supervisory factor provided in Table 2, and the applicable supervisory factor for volatility derivative
  contract hedging sets is equal to 5 times the supervisory factor provided in Table 2.

c. Supervisory Delta Adjustment
    Under the proposal, a banking organization would have applied the 
supervisory delta adjustment to account for the sensitivity of a 
derivative contract to the underlying primary risk factor, including 
the correct sign (positive for long and negative for short) to account 
for the direction of the derivative contract amount relative to the 
primary risk factor. Because option contracts are nonlinear, the 
proposal would have required a banking organization to use the Black-
Scholes Model to determine the supervisory delta adjustment.
    Some commenters argued that use of the Black-Scholes Model is not 
appropriate for certain path-dependent options, because their price is 
not determined by a single price but instead is determined by the path 
of the price for the underlying asset during the option's tenor. For 
such path-dependent options, the commenters asked that banking 
organizations instead be allowed to use existing internal models. 
Similarly, other commenters requested allowing banking organizations to 
use modeled volatilities for purposes of the supervisory delta 
adjustment, rather than the volatilities prescribed by the proposal. 
Conversely, other commenters supported the agencies' proposal with 
respect to the calibration of supervisory deltas.
    As generally noted above, SA-CCR is a standardized framework, and 
the use of internal models to determine option volatility would 
generally not be appropriate for a standardized approach that is 
intended to be implementable by all banking organizations and used to 
facilitate supervisory assessments of comparability across banking 
organizations. Allowing banking organizations to use internal models 
for purposes of the final rule would not support these objectives. The 
agencies note that advanced approaches banking organizations may 
continue to use IMM, which is a model-based approach, to determine the 
exposure amount of derivative contracts for purposes of calculating 
advanced approaches total risk-weighted assets.\97\
---------------------------------------------------------------------------

    \97\ See supra note 25.
---------------------------------------------------------------------------

    The final rule adopts the supervisory delta adjustment as proposed. 
Under Sec.  _.132(c)(9)(iii) of the final rule, the supervisory delta 
adjustment for derivative contracts that are not options or 
collateralized debt obligation tranches must account only for the 
direction of the derivative contract (positive or negative) with 
respect to the underlying risk factor, as such contracts are considered 
to be linear in the primary risk factor. Accordingly, the supervisory 
delta adjustment equals one if such a derivative contract is long the 
primary risk factor and negative one if it is short the primary risk 
factor.
    As noted above, because options contracts are nonlinear, a banking 
organization must use the Black-Scholes Model to determine the 
supervisory delta adjustment for options contracts. However, because 
the Black-Scholes Model assumes that the underlying risk factor is 
greater than zero, consistent with the proposal, the final rule 
incorporates a parameter, lambda ([lgr]), so that the Black-Scholes 
Model may be used where the underlying risk factor has a negative 
value. In particular, the Black Scholes formula provides a ratio, P/K, 
as an input to the natural logarithm function. P is the fair value of 
the underlying instrument and K is the strike price. The natural 
logarithm function can be defined only for amounts greater than zero, 
and therefore, a reference risk factor with a negative value (e.g., 
negative interest rates) would make the supervisory delta adjustment 
inoperable.
---------------------------------------------------------------------------

    \98\ Under the final rule, a banking organization must represent 
binary options with strike K as the combination of one bought 
European option and one sold European option of the same type as the 
original option (put or call) with the strike prices set equal to 
0.95 * K and 1.05 * K. The size of the position in the European 
options must be such that the payoff of the binary option is 
reproduced exactly outside the region between the two strikes. The 
absolute value of the sum of the adjusted derivative contract 
amounts of the bought and sold options is capped at the payoff 
amount of the binary option.

---------------------------------------------------------------------------

[[Page 4386]]

[GRAPHIC] [TIFF OMITTED] TR24JA20.006

Where:

[PHgr] is the standard normal cumulative distribution function;
P equals the current fair value of the instrument or risk factor, as 
applicable, underlying the option;
K equals the strike price of the option;
T equals the number of business days until the latest contractual 
exercise date of the option; and
[lgr] equals zero for all derivative contracts, except that for 
interest rate options that reference currencies currently associated 
with negative interest rates [lgr] must be equal to max {-L + 0.1%; 
0{time} ; \99\ and
---------------------------------------------------------------------------

    \99\ The same value of [lgr]i must be used for all 
interest rate options that are denominated in the same currency. The 
value of [lgr]i for a given currency would be equal to 
the lowest value L of Pi and Ki of all 
interest rate options in a given currency that the banking 
organization has with all counterparties.
---------------------------------------------------------------------------

[sigma] equals the supervisory option volatility, determined in 
accordance with Table 2 of the preamble.

    Consistent with the proposal, under the final rule, for a 
derivative contract that can be represented as a combination of 
standard option payoffs (such as collar, butterfly spread, calendar 
spread, straddle, and strangle),\100\ a banking organization must treat 
each standard option component as a separate derivative contract. For a 
derivative contract that includes multiple-payment options (such as 
interest rate caps and floors),\101\ a banking organization must 
represent each payment option as a combination of effective single-
payment options (such as interest rate caplets and floorlets). A 
banking organization cannot decompose linear derivative contracts (such 
as swaps) into components.
---------------------------------------------------------------------------

    \100\ A collar is a combination of a long position in the stock, 
a long put option and a short call option, in which the investor 
gives up the upside on the stock (by selling the call option) to 
obtain downside protection (through the purchase of the put option).
    A butterfly spread consists of a long put (call) with a low 
exercise price, a long put (call) with a high exercise price, and 
two short puts (calls) with an intermediate exercise price, in which 
the investor earns a profit if the underlying asset equals the 
intermediate exercise price of two short puts (calls) but has 
limited their potential loss to no more than the low exercise price 
of the long put (call).
    A calendar spread consists of a short call (put) option and a 
long call (put) option on the same underlying stock and with the 
same exercise price, but with different maturities. If the investor 
expects limited price movement on the stock in the near-term but a 
significant longer-term price increase, the investor will sell the 
short-dated call option and purchase the long-dated call option.
    A straddle consists of a long (short) call option and long 
(short) put option on the same underlying stock, with the same 
exercise price and with the same maturity, in which the investor 
pays (receives) two option premiums upfront. In a long straddle, the 
investor pays two premiums upfront for the options in order to hedge 
against expected large future stock price moves regardless of 
direction. In a short straddle, the investor receives two option 
premiums upfront based on their expectation of low future price 
volatility.
    A strangle consists of a call and put option on the same 
underlying stock and with the same exercise date, but with different 
exercise prices. The strategy is similar to the straddle, but the 
investor is purchasing (selling) out-of-the-money options in a 
strangle, while in a straddle, the investor is purchasing (selling) 
at-the-money options.
    \101\ An interest rate cap is a series of interest rate call 
options (``caplets'') in which the option seller pays the option 
buyer when the reference rate exceeds the predetermined level in the 
contract. An interest rate floor is a series of interest rate put 
options (``floorlets'') in which the option seller pays the options 
buyer when the reference rate falls below the contractual floor.
---------------------------------------------------------------------------

    For a derivative contract that is a collateralized debt obligation 
tranche, a banking organization must determine the supervisory delta 
adjustment according to the following formula:
[GRAPHIC] [TIFF OMITTED] TR24JA20.007

Where:

A is the attachment point, which equals the ratio of the notional 
amounts of all underlying exposures that are subordinated to the 
banking organization's exposure to the total notional amount of all 
underlying exposures, expressed as a decimal value between zero and 
one; \102\ and
---------------------------------------------------------------------------

    \102\ In the case of a first-to-default credit derivative, there 
are no underlying exposures that are subordinated to the banking 
organization's exposure and A = 0. In the case of a second-or-
subsequent-to-default credit derivative, the smallest (n-1) notional 
amounts of the underlying exposures are subordinated to the banking 
organization's exposure.
---------------------------------------------------------------------------

D is the detachment point, which equals one minus the ratio of the 
notional amounts of all underlying exposures that are senior to the 
banking organization's exposure to the total notional amount of all 
underlying exposures, expressed as a decimal value between zero and 
one.

    The final rule applies a positive sign to the resulting amount if 
the banking organization purchased the collateralized debt obligation 
tranche and applies a negative sign if the banking organization sold 
the collateralized debt obligation tranche.
d. Maturity Factor
    The proposal would have provided separate maturity factors based on 
whether a derivative contract is subject to a variation margin 
agreement. For derivative contracts subject to a variation margin 
agreement, the maturity factor would have been based on the ratio of 
the supervisory-provided MPOR applicable to the type of derivative 
contract and 250 business days. The proposal would have defined MPOR as 
the period from the most recent exchange of collateral under a 
variation margin agreement with a defaulting counterparty until the

[[Page 4387]]

derivative contracts are closed out and the resulting market risk is 
re-hedged. For derivative contracts subject to a variation margin 
agreement that are not cleared transactions, MPOR would have been 
floored at ten business days. For derivative contracts subject to a 
variation margin agreement and that are cleared transactions, MPOR 
would have been floored at five business days. For derivative contracts 
not subject to a variation margin agreement, the maturity factor would 
have been based on the ratio of the remaining maturity of the 
derivative contract, capped at 250 business days, with the numerator 
floored at ten business days.
    Several commenters asked the agencies to clarify whether a five-
business-day MPOR floor would apply to the exposure of a clearing 
member banking organization to its client that arises when the clearing 
member banking organization is acting as a financial intermediary and 
enters into an offsetting derivative contract with a CCP or when the 
clearing member banking organization provides a guarantee to the CCP on 
the performance of the client on a derivative contract with the CCP. In 
response to comments, the final rule applies a five-business-day MPOR 
floor to the exposure of a clearing member banking organization to its 
client that arises when the clearing member banking organization is 
acting as a financial intermediary and enters into an offsetting 
derivative contract with a QCCP or when the clearing member banking 
organization provides a guarantee to the QCCP on the performance of the 
client on a derivative contract with the QCCP (defined under this final 
rule as a ``client-facing derivative transaction,'' as described 
below).\103\
---------------------------------------------------------------------------

    \103\ Section 132(c)(9)(iv)(A)(2)(ii) of the proposed rule text 
would have applied a five-business-day MPOR floor to cleared 
transactions subject to a variation margin agreement. In order to 
capture the longer close-out period required in the event of a 
central counterparty failure, the final rule text at section 
132(c)(9)(iv)(A)(1) provides that MPOR cannot be less than ten 
business days for transactions subject to a variation margin 
agreement that are not client-facing derivative transactions. The 
final rule is consistent with the Basel Committee standard regarding 
capital requirements for bank exposures to central counterparties 
and with the treatment of these transactions under the agencies' 
implementation of CEM. See infra note 116.
---------------------------------------------------------------------------

    Some commenters noted that the criteria for doubling the MPOR under 
the proposal is different from the existing criteria under the IMM. 
Under the proposal, a banking organization would have been required to 
double the applicable MPOR floor if the derivative contract is subject 
to an outstanding dispute over margin. Under the IMM, a banking 
organization must double the applicable MPOR only if over the two 
previous quarters more than two margin disputes in a netting set have 
occurred and lasted longer than the MPOR. The agencies are aligning the 
treatment in the final rule with this approach. Therefore, a banking 
organization must double the applicable MPOR only if over the two 
previous quarters more than two margin disputes in a netting set have 
occurred, and each margin dispute lasted longer than the MPOR.\104\ 
This approach is consistent with the treatment under IMM, which has 
generally functioned as intended. In addition, alignment with IMM will 
reduce operational burden for firms that are required to use SA-CCR for 
calculating standardized risk-weighted assets, but have received prior 
supervisory approval to use IMM to calculate risk-weighted assets under 
the advanced approaches.
---------------------------------------------------------------------------

    \104\ The adopted treatment is also consistent with the 
application of the standard supervisory haircuts under Sec.  
_.132(b)(2)(ii)(A)(4) of the final rule.
---------------------------------------------------------------------------

    Other commenters requested revising the proposal to allow banking 
organizations to treat all derivative contracts with a commercial end-
user counterparty as subject to a variation margin agreement and apply 
a holding period of no more than ten business days, regardless of 
whether the derivative contract is subject to a variation margin 
agreement. The reasons provided by commenters for this request were to 
help address the types of concerns raised by commenters regarding 
exposures to commercial end-user counterparties, as discussed 
previously. The final rule does not provide maturity factors based on 
the type of counterparty to the derivative contract because the 
agencies intend for the maturity factor to capture the time period to 
close out a defaulted counterparty and the degree of legal certainty 
with respect to such close-out period. With respect to comments 
regarding the MPOR for exposures to commercial end-user counterparties, 
removing the alpha factor for derivative contracts with such 
counterparties should help to address the commenters' concerns.
    Some commenters asked the agencies to replace the term ``exotic 
derivative contracts'' \105\ under the proposal with ``derivative 
contracts that are not easily replaceable'' in order to allow banking 
organizations to rely on existing operational processes rather than 
requiring the establishment of new ones to identify ``exotic derivative 
contracts.'' These commenters noted that banking organizations have 
already established the operational processes necessary for identifying 
derivative contracts as ``not easily replaceable'' to comply with other 
aspects of the capital rule. In response to commenters' concerns, the 
agencies are replacing the term ``exotic derivative contract'' with 
``derivative contract that cannot be easily replaced.''
---------------------------------------------------------------------------

    \105\ Under the proposal, a banking organization would have been 
required to use a MPOR of 20 business days for a derivative contract 
that is within a netting set that is composed of more than 5,000 
derivative contracts that are not cleared transactions, or if a 
netting set contains one or more trades involving illiquid 
collateral or exotic derivative contracts.
---------------------------------------------------------------------------

    For the reasons described above, the agencies are adopting as final 
the proposed maturity factor adjustment under Sec.  _.132(c)(9)(iv) of 
the final rule, subject to the clarifications and revisions discussed 
above. Under the final rule, for derivative contracts not subject to a 
variation margin agreement, or derivative contracts subject to a 
variation margin agreement under which the counterparty to the 
variation margin agreement is not required to post variation margin to 
the banking organization, a banking organization must determine the 
maturity factor using the following formula:
[GRAPHIC] [TIFF OMITTED] TR24JA20.008

    Where M equals the greater of ten business days and the remaining 
maturity of the contract, as measured in business days.
    For derivative contracts subject to a variation margin agreement 
under which the counterparty must post variation margin, a banking 
organization must determine the maturity factor using the following 
formula:

[[Page 4388]]

[GRAPHIC] [TIFF OMITTED] TR24JA20.009

    Where MPOR refers to the period from the most recent exchange of 
collateral under a variation margin agreement with a defaulting 
counterparty until the derivative contracts are closed out and the 
resulting market risk is re-hedged.
    The final rule introduces the term ``client-facing derivative 
transactions'' to describe the exposure of a clearing member banking 
organization to its client that arises when the clearing member banking 
organization is either acting as a financial intermediary and enters 
into an offsetting derivative contract with a QCCP or when the clearing 
member banking organization provides a guarantee to the QCCP on the 
performance of the client for a derivative contract with the QCCP. 
Under the final rule, the agencies are clarifying that the MPOR is 
floored at five business days for derivative contracts subject to a 
variation margin agreement that are client-facing derivative 
transactions. For all other derivative contracts subject to a variation 
margin agreement, the MPOR is floored at ten business days. If over the 
previous two quarters a netting set is subject to two or more 
outstanding margin disputes that lasted longer than the MPOR, the 
applicable MPOR is twice the MPOR provided for those transactions in 
the absence of such disputes.\106\ For a derivative contract that is 
within a netting set that is composed of more than 5,000 derivative 
contracts that are not cleared transactions, or if a netting set 
contains one or more transactions involving illiquid collateral or a 
derivative contract that cannot be easily replaced, the MPOR is floored 
at 20 business days.
---------------------------------------------------------------------------

    \106\ In general, a party will not have violated its obligation 
to collect or post variation margin from or to a counterparty if: 
The counterparty has refused or otherwise failed to provide or 
accept the required variation margin to or from the party; and the 
party has made the necessary efforts to collect or post the required 
variation margin, including the timely initiation and continued 
pursuit of formal dispute resolution mechanisms; or has otherwise 
demonstrated that it has made appropriate efforts to collect or post 
the required variation margin; or commenced termination of the 
derivative contract with the counterparty promptly following the 
applicable cure period and notification requirements.
---------------------------------------------------------------------------

    For a cleared derivative contract in which on specified dates any 
outstanding exposure of the derivative contract is settled and the fair 
value of the derivative contract is reset to zero, the remaining 
maturity of the derivative contract is the period until the next reset 
date.\107\ In addition, derivative contracts with daily settlement 
would be treated as unmargined derivative contracts. However, as 
discussed in section III.D.4. of this SUPPLEMENTARY INFORMATION, a 
banking organization may elect to treat settled-to-market derivative 
contracts as collateralized-to-market derivative contracts subject to a 
variation margin agreement and apply the maturity factor for derivative 
contracts subject to a variation margin agreement.
---------------------------------------------------------------------------

    \107\ See 12 CFR 3.2 (OCC); 12 CFR 217.2 (Board); and 12 CFR 
324.2 (FDIC).
---------------------------------------------------------------------------

3. PFE Multiplier
    Under the proposal, the PFE multiplier would have recognized, if 
present, the amount of excess collateral available and the negative 
fair value of the derivative contracts within the netting set. 
Specifically, the PFE multiplier would have decreased exponentially 
from a value of one as the value of the financial collateral held 
exceeds the net fair value of the derivative contracts within the 
netting set, subject to a floor of 5 percent. This function accounted 
for the fact that the proposed aggregated amount formula would not have 
recognized financial collateral and would have assumed a zero market 
value for all derivative contracts.
    Several commenters argued that the PFE multiplier is too 
conservative and does not appropriately account for the risk-reducing 
effects of collateral. Some commenters argued that the calibration of 
the aggregated amount for a netting set would result in an overly 
conservative PFE multiplier amount, and that the aggregated amount in 
the PFE multiplier should be divided by at least two to mitigate such 
conservatism. Other commenters argued that because other factors under 
SA-CCR already contribute to the conservative recognition of initial 
margin (e.g., the calibration of the add-on, use of an exponential 
function, and reflection of collateral volatility through haircuts that 
do not allow any diversification across collateral), the agencies 
should decrease the floor to 1 percent because initial margin 
requirements for uncleared swaps under the swap margin rule generally 
are calibrated to a 99 percent confidence level. Additionally, these 
commenters argued that the floor should not be a component of the PFE 
multiplier function but instead should act as an independent floor to 
the recognition of collateral under the PFE function. According to 
these comments, while these changes would result in more risk-sensitive 
initial margin recognition for heavily overcollateralized netting sets, 
the overall impact would remain conservative due to the overcalibration 
of the add-on. Other commenters asked the agencies to recognize the 
effect of collateral on a dollar-for-dollar basis, subject to haircuts, 
similar to the recognition of collateral under the replacement cost 
component of SA-CCR.
    Relative to CEM, SA-CCR is more sensitive to the risk-reducing 
benefits of collateral. However, the agencies recognize that as a 
standardized framework, SA-CCR may not appropriately capture risks in 
all cases (e.g., collateral haircuts may be less than those realized in 
stress periods) and therefore believe it is appropriate to instill 
conservatism. The combination of the exponential function and the floor 
provides adequate recognition of collateral while maintaining a 
sufficient level of conservatism by limiting decreases in PFE due to 
large amounts of collateral and preventing PFE from reaching zero for 
any amount of margin. This ensures that some amount of capital will be 
maintained even in situations where the transaction is 
overcollateralized. The commenters' recommendations could, in certain 
circumstances, undermine these objectives. Therefore, the final rule 
adopts the PFE multiplier as proposed.
    Under the final rule, a banking organization must calculate the PFE 
multiplier using the formula set forth in Sec. _.132(c)(7)(i) of the 
final rule, as follows:
[GRAPHIC] [TIFF OMITTED] TR24JA20.010

Where:

V is the sum of the fair values (after excluding any valuation 
adjustments) of the derivative contracts within the netting set;

[[Page 4389]]

C is the sum of the net independent collateral amount and the 
variation margin amount applicable to the derivative contracts 
within the netting set; and
A is the aggregated amount of the netting set.

    The PFE multiplier decreases as the net fair value of the 
derivative contracts within the netting set less the amount of 
collateral decreases below zero. Specifically, when the component V- C 
is greater than zero, the multiplier is equal to one. When the 
component V- C is less than zero, the multiplier is equal to an amount 
less than one and decreases exponentially in value as the absolute 
value of V- C increases. The PFE multiplier approaches a floor of 5 
percent as the absolute value of V- C becomes very large as compared 
with the aggregated amount of the netting set.
4. PFE Calculation for Nonstandard Margin Agreements
    When a single variation margin agreement covers multiple netting 
sets, the parties exchange variation margin based on the aggregated 
market value of the netting sets--i.e., netting sets with positive and 
negative market values can offset one another to reduce the amount of 
variation margin that the parties are required to exchange. This can 
result, however, in a situation in which margin exchanged between the 
parties will be insufficient relative to the banking organization's 
exposure amount for the netting sets.\108\ To address such a situation, 
the proposal would have required a banking organization to assign a 
single PFE to each netting set covered by a single variation margin 
agreement, calculated as if none of the derivative contracts within the 
netting set are subject to a variation margin agreement. The agencies 
did not receive comments on this aspect of the proposal, and are 
adopting it as proposed under Sec.  _.132(c)(10)(ii) of the final rule.
---------------------------------------------------------------------------

    \108\ For example, consider a variation margin agreement with a 
zero threshold amount that covers two separate netting sets, one 
with a positive market value of 100 and the other with a market 
value of negative 100. The aggregate market value of the netting 
sets would be zero and thus no variation margin would be exchanged. 
However, the banking organization's aggregate exposure amount for 
these netting sets would be equal to 100 because the negative market 
value of the second netting set would not be available to offset the 
positive market value of the first netting set. In the event of 
default of the counterparty, the banking organization would pay the 
counterparty 100 for the second netting set and would be exposed to 
a loss of 100 on the first netting set.
---------------------------------------------------------------------------

    The proposal also would have provided a separate calculation to 
determine PFE for a situation in which a netting set is subject to more 
than one variation margin agreement, or for a hybrid netting set. Under 
the proposal, a banking organization would have divided the netting set 
into sub-netting sets and calculated the aggregated amount for each 
sub-netting set. In particular, all derivative contracts within the 
netting set that are not subject to a variation margin agreement or 
that are subject to a variation margin agreement under which the 
counterparty is not required to post variation margin would have formed 
a single sub-netting set. A banking organization would have been 
required to calculate the aggregated amount for this sub-netting set as 
if the netting set were not subject to a variation margin agreement. 
All derivative contracts within the netting set that are subject to 
variation margin agreements under which the counterparty must post 
variation margin and that share the same MPOR value would have formed 
another sub-netting set. A banking organization would have been 
required to calculate the aggregated amount for this sub-netting set as 
if the netting set were subject to a variation margin agreement, using 
the MPOR value shared by the derivative contracts within the netting 
set.
    Several commenters asked the agencies to allow banking 
organizations to net based solely on whether a QMNA that provides for 
closeout netting per applicable law in the event of default is in 
place. These commenters asserted that netting should not be limited to 
derivative contracts with the same MPOR because the purpose of the MPOR 
is to capture the risks associated with an extended closeout period 
upon a counterparty's default and that differences in MPOR are 
unrelated to the legal ability to net upon closeout, which should be 
based only on legal certainty which is established under U.S. law if 
the netting agreement is a QMNA. In particular, commenters were 
concerned that the proposal would prohibit banking organizations from 
being able to net settled-to-market \109\ derivative contracts with 
collateralized-to-market derivative contracts,\110\ as well as futures-
style options and options with equity-style margining,\111\ even if 
such contracts are within the same netting set.
---------------------------------------------------------------------------

    \109\ See supra note 18.
    \110\ In general, in a collateralized-to-market derivative 
contract, title of transferred collateral stays with the posting 
party.
    \111\ In general, for margining for options, the buyer of the 
option pays a premium upfront to the seller and there is no exchange 
of variation margin. The buyer, however, may credit the net value of 
the option against its initial margin requirements. The seller, in 
turn, receives a debit against its initial margin requirement in the 
amount of the net option value. The option is subject to daily 
revaluation with increases and decreases to the net option value 
resulting in adjustments to the buyer's and the seller's net option 
value credits and debits. In addition, under U.S. GAAP, the option 
is an asset and the banking organization could use it in the event 
of a client's default to offset any other losses the buyer may have.
---------------------------------------------------------------------------

    The proposal's distinction between margined and unmargined 
derivative contracts would not have fully captured the relationship 
between settled-to-market derivative contracts and collateralized-to-
market derivative contracts that are cleared transactions as defined 
under Sec.  _.2 of the capital rule. In particular, under both cleared 
settled-to-market and cleared collateralized-to-market derivative 
transactions a banking organization must either make a settlement 
payment or exchange collateral to support its outstanding credit 
obligation to the counterparty on a periodic basis. Such contracts are 
functionally and economically similar from a credit risk perspective, 
and therefore, the final rule allows a banking organization to elect, 
at the netting set level, to treat all the settled-to-market derivative 
contracts within the netting set that are cleared transactions as 
subject to a variation margin agreement and receive the benefits of 
netting with cleared collateralized-to-market derivative contracts. 
That is, a banking organization that makes such election will treat 
such cleared settled-to-market derivative contracts as cleared 
collateralized-to-market derivative contracts, using the higher 
maturity factor applicable to collateralized-to-market derivative 
contracts.\112\
---------------------------------------------------------------------------

    \112\ Sec.  _.132(c)(9)(iv)(A) of the final rule. Similar to the 
treatment under CEM, SA-CCR provides a lower maturity factor for 
cleared settled-to-market derivative contracts that meet certain 
criteria. See ``Regulatory Capital Treatment of Certain Centrally-
cleared Derivative Contracts Under Regulatory Capital Rules'' 
(August 14, 2017), OCC Bulletin: 2017-27; Board SR letter 07-17; and 
FDIC Letter FIL-33-2017.
---------------------------------------------------------------------------

    Similarly, for listed options, the agencies are clarifying that a 
banking organization may elect to treat listed options on securities or 
listed options on futures with equity-style margining that are cleared 
transactions as margined derivatives. Under the final rule, a banking 
organization may elect to treat all such transactions within the same 
netting set as being subject to a variation margin agreement with a 
zero threshold amount and a zero minimum transfer amount, given that 
the daily net option value credits and debits are economically 
equivalent to an exchange of variation margin under a zero threshold 
and a zero minimum transfer amount. Consistent with the treatment 
described above for settled-to-market derivative contracts that are 
treated as collateralized-to-market, a banking

[[Page 4390]]

organization that elects to apply this treatment must apply the 
maturity factor applicable to margined derivative contracts.
    Except for the changes described above, the agencies are adopting 
the proposed approach for netting sets subject to more than one 
variation margin agreement, or for a hybrid netting set.\113\
---------------------------------------------------------------------------

    \113\ Sec.  _.132(c)(11)(ii) of the final rule.
---------------------------------------------------------------------------

IV. Revisions to the Cleared Transactions Framework

    Under the capital rule, a banking organization must maintain 
regulatory capital for its exposure to, and certain collateral posted 
in connection with, a derivative contract that is a cleared transaction 
(as defined under Sec.  _.2 of the capital rule). A clearing member 
banking organization also must hold risk-based capital for its default 
fund contributions.\114\ The proposal would have revised the cleared 
transactions framework under the capital rule by replacing CEM with SA-
CCR for advanced approaches banking organizations in both the advanced 
approaches and standardized approach. Non-advanced approaches banking 
organizations would have been permitted to elect to use SA-CCR or CEM 
for noncleared and cleared derivative contracts, but would have been 
required to use the same approach for both.\115\ In addition, the 
proposal would have simplified the formula that a clearing member 
banking organization must use to determine the risk-weighted asset 
amount for its default fund contributions. The proposed revisions were 
consistent with standards developed by the Basel Committee.\116\
---------------------------------------------------------------------------

    \114\ A default fund contribution means the funds contributed or 
commitments made by a clearing member banking organization to a 
CCP's mutualized loss-sharing arrangement. See 12 CFR 3.2 (OCC); 12 
CFR 217.2 (Board); and 12 CFR 324.2, (FDIC).
    \115\ At the time of the proposal, an advanced approaches 
banking organization meant a banking organization that has at least 
$250 billion in total consolidated assets or if it has consolidated 
on-balance sheet foreign exposures of at least $10 billion, or if it 
is a subsidiary of a depository institution, bank holding company, 
savings and loan holding company or intermediate holding company 
that is an advanced approaches banking organization. Under the 
tailoring proposals adopted by the agencies, the supplementary 
leverage ratio also would have applied to banking organizations 
subject to Category III. Banking organizations subject to Category 
III standards would have been permitted to use CEM or a modified 
version of SA-CCR for purposes of the supplementary leverage ratio, 
but consistent with the proposal to implement SA-CCR, they would 
have been required to use the same approach (CEM or SA-CCR) for all 
purposes under the capital rule. See ``Proposed Changes to the 
Applicability Thresholds for Regulatory Capital and Liquidity 
Requirements,'' 83 FR 66024 (December 21, 2018) and ``Changes to 
Applicability Thresholds for Regulatory Capital Requirements for 
Certain U.S. Subsidiaries of Foreign Banking Organizations and 
Application of Liquidity Requirements to Foreign Banking 
Organizations, Certain U.S. Depository Instititution Holding 
Companies, and Certain Depository Institution Subsidiaries,'' 84 FR 
24296 (May 24, 2019).
    \116\ See ``Capital requirements for bank exposures to central 
counterparties,'' Basel Committee on Banking Supervision (April 
2014), https://www.bis.org/publ/bcbs282.pdf.
---------------------------------------------------------------------------

A. Trade Exposure Amount

    Under the proposal, an advanced approaches banking organization 
that elected to use SA-CCR for purposes of determining the exposure 
amount of a noncleared derivative contract under the advanced 
approaches would have been required to also use SA-CCR (instead of IMM) 
to determine the trade exposure amount for a cleared derivative 
contract under the advanced approaches. In addition, an advanced 
approaches banking organization would have been required to use SA-CCR 
to determine the exposure amount for both its cleared and noncleared 
derivative contracts under the standardized approach. A non-advanced 
approaches banking organization that elected to use SA-CCR for purposes 
of determining the exposure amount of a non-cleared derivative contract 
would have been required to use SA-CCR (instead of CEM) to determine 
the trade exposure amount for a cleared derivative contract.
    Several commenters recommended providing advanced approaches 
banking organizations the option to use SA-CCR or IMM for purposes of 
the cleared transactions framework, regardless of the banking 
organization's election to use SA-CCR or IMM to determine the exposure 
amount of noncleared derivative contracts under the advanced 
approaches. As discussed in section II.A. of this SUPPLEMENTARY 
INFORMATION, the agencies believe that requiring an advanced approaches 
banking organization to use one of either SA-CCR or IMM for both 
cleared and noncleared derivative contracts under the advanced 
approaches promotes consistency in the regulatory capital treatment of 
derivative contracts and facilitates the supervisory assessment of a 
banking organization's capital management program.
    Some commenters asked the agencies to remove from the calculation 
of trade exposure amount the requirement to include non-cash initial 
margin posted to a CCP that is not held in a bankruptcy-remote manner. 
According to commenters, this requirement would overstate the banking 
organization's exposure to such collateral, because collateral posted 
to a CCP remains on the balance sheet of the banking organization and 
must be reflected in risk-weighted assets under the capital rule. 
Collateral held in a manner that is not bankruptcy remote exposes a 
banking organization to risk of loss should the CCP fail and the 
banking organization is unable to recover its collateral. This 
counterparty credit risk is separate from, and in addition to, the risk 
inherent to the collateral itself. Thus, the final rule does not remove 
from the calculation of trade exposure amount the requirement to 
include non-cash initial margin posted to a CCP that is not held in a 
bankruptcy remote manner.
    Other commenters asked for clarification regarding the scope of 
transactions that would be subject to the cleared transactions 
framework. In particular, the commenters asked the agencies to clarify 
the treatment of an exposure between a banking organization and a 
clearing member where the banking organization acts as agent for its 
client for a cleared transaction by providing a guarantee to the 
clearing member of the QCCP for the performance of the client. The 
final rule clarifies that, in such a situation, the banking 
organization may treat its exposure to the transaction as if the 
banking organization were the clearing member and directly facing the 
QCCP (i.e., the banking organization would have no exposure to the 
clearing member or the QCCP as long as it does not provide a guarantee 
to the client on the performance of the clearing member or QCCP).\117\ 
Furthermore, in such a situation, the banking organization may treat 
the exposure resulting from the guarantee of the client's performance 
obligations with respect to the underlying derivative contract as a 
client-facing derivative transaction.\118\ Similarly, under CEM, the 
banking organization may adjust the exposure amount for the client-
facing derivative transaction by applying a scaling factor of the 
square root of \1/2\ (which equals 0.707107) to such exposure or higher 
if the banking organization determines a longer holding period is 
appropriate.\119\
---------------------------------------------------------------------------

    \117\ See 12 CFR 3.3(a) (OCC); 12 CFR 217.3(a) (Board); and 12 
CFR 324.3(a) (FDIC).
    \118\ As described in section III.D.2.d. of this Supplementary 
Information, for the client-facing derivative transaction (i.e., the 
banking organization's exposure to the client due to the guarantee), 
the banking organization would treat the exposure as a non-cleared 
derivative contract using the five-business-day minimum MPOR.
    \119\ See 12 CFR 3.34(e) (OCC); 12 CFR 217.34(e) (Board); and 12 
CFR 324.34(e) (FDIC).
---------------------------------------------------------------------------

    Some commenters asked the agencies to clarify how a clearing member 
banking organization that acts as agent on behalf of a client should 
reflect its temporary exposure to the client for the

[[Page 4391]]

collateral posted by the clearing member banking organization to the 
CCP, which the client subsequently will post to the clearing member 
banking organization. The commenters stated that the collateral 
advanced by the clearing member banking organization on behalf of the 
client creates a receivable under U.S. GAAP until the clearing member 
banking organization receives the collateral from the client. 
Accordingly, the commenters sought clarification on whether the amount 
of such receivables should be reflected in exposure amount of the 
client-facing derivative transaction or treated as a separate exposure 
to the client. Such receivables expose the clearing member banking 
organization to risk of loss should the client fail to subsequently 
post the collateral to the clearing member banking organization. This 
credit risk is separate from, and in addition to, the counterparty 
credit risk of the exposure arising from the client-facing derivative 
transaction, which represents the guarantee the clearing member banking 
organization provides for the client's performance on the underlying 
derivative transaction. Thus, consistent with U.S. GAAP, a clearing 
member banking organization must treat such a receivable as a credit 
exposure to the client for purposes of the capital rule, separate from 
the treatment applicable to the client-facing derivative transaction 
under this final rule.
    For the reasons discussed above, the agencies are adopting as final 
under Sec.  _.133(b) of the final rule the proposal to replace CEM with 
SA-CCR for advanced approaches banking organizations in the capital 
rule, with one modification to introduce the defined term ``client-
facing derivative transactions'' and clarify that such exposures 
receive a five-business-day minimum MPOR under SA-CCR, as discussed 
above. An advanced approaches banking organization that elects to use 
SA-CCR for purposes of determining the exposure amount of its 
noncleared derivative contracts under the advanced approaches must also 
use SA-CCR (instead of IMM) to determine the trade exposure amount for 
its cleared derivative contracts under the advanced approaches.\120\
---------------------------------------------------------------------------

    \120\ As discussed in section II.A. of this Supplementary 
Information, an advanced approaches banking organization must use 
SA-CCR to determine the trade exposure amount for its cleared 
derivative contracts and the exposure amount for its noncleared 
derivative contracts under the standardized approach.
---------------------------------------------------------------------------

    A non-advanced approaches banking organization may continue to use 
CEM to determine the trade exposure amount for its cleared derivative 
contracts under the standardized approach. However, a non-advanced 
approaches banking organization that elects to use SA-CCR to calculate 
the exposure amount for its noncleared derivative contracts must use 
SA-CCR to calculate the trade exposure amount for its cleared 
derivative contracts.

B. Treatment of Default Fund Contributions

    The proposal would have revised certain of the approaches that a 
banking organization could use to determine the risk-weighted asset 
amount for its default fund contributions. Specifically, the proposal 
would have eliminated method one and method two under section 133(d)(3) 
of the capital rule, either of which may be used by a clearing member 
banking organization to determine the risk-weighted asset amount for 
its default fund contributions to a QCCP.\121\ In its place, the 
proposal would have implemented a single approach for a clearing member 
banking organization to determine the risk-weighted asset amount for 
its default fund contributions to a QCCP, which would have been less 
complex than method one but also more granular than method two. The 
proposal would have maintained the approach by which a clearing member 
banking organization determines its risk-weighted asset amount for its 
default fund contributions to a CCP that is not a QCCP.\122\
---------------------------------------------------------------------------

    \121\ Method one is a complex three-step approach that compares 
the default fund of the QCCP to the capital the QCCP would be 
required to hold if it were a banking organization and provides a 
method to allocate the default fund deficit or excess back to the 
clearing member. Method two is a simplified approach in which the 
risk-weighted asset amount for a default fund contribution to a QCCP 
equals 1,250 percent multiplied by the default fund contribution, 
subject to a cap.
    \122\ In that case, the risk-weighted asset amount is the sum of 
the clearing member banking organization's default fund 
contributions multiplied by 1,250 percent.
---------------------------------------------------------------------------

    Some commenters asked the agencies to clarify that a banking 
organization's commitment to enter into reverse repurchase agreements 
with a CCP are not default fund contributions. Certain CCPs may require 
clearing members to provide funding in the form of reverse repurchase 
agreements in the event of a clearing member's default in order to 
support the liquidity needs of the CCP. The capital rule defines 
default fund contributions as the funds contributed to or commitments 
made by a clearing member to a CCP's mutualized loss sharing 
arrangements. The proposal did not contemplate changes to the 
definition of default fund contributions and the final rule does not 
revise this definition. Whether or not a particular arrangement meets 
the definition in the regulation depends on the facts and circumstances 
of the particular arrangement. The agencies may consider whether 
revisions to the definition are necessary in connection with future 
rulemakings if the definition is not functioning as intended.
    Other commenters asked the Board to revise Regulation HH \123\ to 
require QCCPs regulated by the Board to make available to clearing 
member banking organizations the information required to calculate the 
QCCP's hypothetical capital requirement. The commenters raised concerns 
that while domestic QCCPs will likely be prepared to provide the 
requisite data to calculate the hypothetical capital requirement, no 
regulation requires them to do so, and that foreign QCCPs are not 
subject to U.S. regulation and may not be prepared to provide the 
requisite data. The commenters also encouraged the agencies to work 
with the SEC and the CFTC to make similar revisions to their 
regulations applicable to domestic QCCPs and with international 
standard setters and foreign regulators to ensure that foreign QCCPs 
will be capable of providing U.S. banking organizations with the data 
required for the hypothetical capital calculations under the proposal. 
Lastly, the commenters asked that the agencies clarify that banking 
organizations may rely on the amount of a foreign QCCP's hypothetical 
capital requirement produced under a Basel-compliant SA-CCR regime.
---------------------------------------------------------------------------

    \123\ See 12 CFR part 234. Regulation HH relates to the 
regulation of designated financial market utilities by the Board.
---------------------------------------------------------------------------

    The proposal did not contemplate changes to Regulation HH and thus 
the agencies view these comments as out of scope for this rulemaking. 
In addition, the Board's Regulation HH serves a different purpose than 
the capital rule and covers a different set of entities. However, the 
agencies recognize the concerns raised by the commenters with respect 
to potential difficulties for banking organizations in calculating the 
hypothetical capital requirement of a QCCP and intend to monitor 
whether banking organizations experience difficulties obtaining the 
hypothetical capital requirement (or the requisite information required 
to calculated it) from the QCCP to perform this calculation.\124\ In 
recognition of these

[[Page 4392]]

concerns, the final rule allows banking organizations that elect to use 
SA-CCR to continue to use method 1 or method 2 under CEM to calculate 
the risk-weighted asset amount for default fund contributions until 
January 1, 2022.\125\ This is intended to provide sufficient time for 
clearing member banking organizations to coordinate with CCPs to obtain 
the hypothetical capital requirement produced under SA-CCR (or the 
requisite information to calculate it) from the CCPs, in order for such 
entities to qualify as QCCPs after the mandatory compliance date. The 
agencies are also clarifying that after January 1, 2022, the mandatory 
compliance date, a banking organization that is using SA-CCR may only 
consider a foreign CCP to be a QCCP for purposes of the capital rule if 
the foreign CCP produces its hypothetical capital requirement under SA-
CCR (as implemented by the CCP's home country in a manner consistent 
with the Basel Committee standard). The agencies intend to monitor 
whether banking organizations experience difficulties obtaining the 
hypothetical capital requirement (or alternatively, the required data) 
after the January 1, 2022, mandatory compliance date. If, after January 
2022, significant obstacles remain after a banking organization has 
made best efforts to obtain the necessary information from CCPs (e.g., 
due to delays in the implementation of the Basel Committee standard in 
other jurisdictions), its primary Federal regulator may permit the 
banking organization to use method 2 of CEM to calculate risk-weighted 
asset amounts for default fund contributions for a specified period.
---------------------------------------------------------------------------

    \124\ Under the capital rule, if a CCP does not provide the 
hypothetical capital requirement (or, alternatively, the required 
data) the CCP is not a QCCP and a banking organization must apply a 
risk weight of 1250 percent to its default fund contributions to the 
CCP. See definition of ``qualifying central counterparty'' under 
Sec.  _.2 of the capital rule, 12 CFR 3.2 (OCC); 12 CFR 217.2 
(Board); and 12 CFR 324.2 (FDIC).
    \125\ In cases where a banking organization uses method 1 to 
calculate the risk-weighted asset amount for a default fund 
contribution, a QCCP that provides the banking organization its 
hypothetical capital requirement produced using CEM would still 
qualify as a QCCP until January 1, 2022.
---------------------------------------------------------------------------

    The agencies otherwise are generally adopting without change the 
proposed revisions to the risk-weighted asset calculation for default 
fund contributions under Sec.  _.133(d) of the final rule.\126\ Thus, 
to determine the capital requirement for a default fund contribution to 
a QCCP, a clearing member banking organization first calculates the 
hypothetical capital requirement of the QCCP (KCCP), unless 
the QCCP has already disclosed it, in which case the banking 
organization must rely on that disclosed figure. In either case, a 
banking organization may choose to use a higher amount of 
KCCP than the minimum calculated under the formula or 
disclosed by the QCCP if the banking organization has concerns about 
the nature, structure, or characteristics of the QCCP. In effect, 
KCCP serves as a consistent measure of a QCCP's default fund 
amount.
---------------------------------------------------------------------------

    \126\ In a nonsubstantive change, the agencies moved paragraphs 
(i) and (ii) of Sec.  _.133(d)(3) of the proposed rule text to 
paragraphs (iv) and (v) under Sec.  _.133(d)(6) of the final rule 
text. The agencies made this change because these sections provide 
instruction on calculating EAD for default fund contribution 
accounts, which are covered under Sec.  _.133(d)(6). In addition, 
the agencies changed the reference to (e)(4) in Sec.  _.133(d)(3) of 
the proposed rule text to (d)(4).
---------------------------------------------------------------------------

    Under the final rule, a clearing member banking organization must 
calculate KCCP according to the following formula:

KCCP = [Sigma]CMi EADi * 1.6 percent,

Where:

CMi is each clearing member of the QCCP; and
EADi is the exposure amount of the QCCP to each clearing 
member of the QCCP, as determined under Sec.  _.133(d)(6).\127\
---------------------------------------------------------------------------

    \127\ Section 133(d)(6) of the proposed rule text would have 
required a banking organization to sum the exposure amount of all 
underlying transactions, the collateral held by the CCP, and any 
prefunded default contributions. In a technical correction to the 
proposal, and to recognize that collateral held by the QCCP and any 
prefunded default fund contributions serve to mitigate this 
exposure, the final rule text at section 133(d)(6) clarifies that 
banking organizations under the final rule must subtract from the 
exposure amount the value of collateral held by the QCCP and any 
prefunded default contributions. The final rule is consistent with 
the Basel Committee standard regarding capital requirements for bank 
exposures to central counterparties. See supra note 116.

    The component EADi includes both the clearing member banking 
organization's own transactions, the client transactions guaranteed by 
the clearing member, and all values of collateral held by the QCCP 
(including the clearing member banking organization's pre-funded 
default fund contribution) against these transactions. The 1.6 percent 
amount represents the product of a capital ratio of 8 percent and a 20 
percent risk weight of a clearing member banking organization.
    Subject to the transitional provisions described above, as of 
January 1, 2022, a banking organization that is required or elects to 
use SA-CCR to determine the exposure amount for its derivative 
contracts under the standardized approach must use a KCCP 
calculated using SA-CCR for both the standardized approach and the 
advanced approaches.\128\ For purposes of calculating KCCP, 
the PFE multiplier includes collateral held by a QCCP in which the QCCP 
has a legal claim in the event of the default of the member or client, 
including default fund contributions of that member. In addition, the 
QCCP must use a MPOR of ten business days in the maturity factor 
adjustment. A banking organization that elects to use CEM to determine 
the exposure amount of its derivative contracts under the standardized 
approach must use a KCCP calculated using CEM.
---------------------------------------------------------------------------

    \128\ The final rule does not revise the calculations for 
determining the exposure amount of repo-style transactions for 
purposes of determining the risk-weighted asset amount of a banking 
organization's default fund contributions.
---------------------------------------------------------------------------

    EAD must be calculated separately for each clearing member banking 
organization's sub-client accounts and sub-house account (i.e., for the 
clearing member's proprietary activities). If the clearing member 
banking organization's collateral and its client's collateral are held 
in the same account, then the EAD of that account would be the sum of 
the EAD for the client-related transactions within the account and the 
EAD of the house-related transactions within the account. In such a 
case, for purposes of determining such EADs, the independent collateral 
of the clearing member banking organization and its client must be 
allocated in proportion to the respective total amount of independent 
collateral posted by the clearing member banking organization to the 
QCCP. This treatment protects against a clearing member banking 
organization recognizing client collateral to offset the QCCP's 
exposures to the clearing member banking organization's proprietary 
activity in the calculation of KCCP.
    In addition, if any account or sub-account contains both derivative 
contracts and repo-style transactions, the EAD of that account is the 
sum of the EAD for the derivative contracts within the account and the 
EAD of the repo-style transactions within the account. If independent 
collateral is held for an account containing both derivative contracts 
and repo-style transactions, then such collateral must be allocated to 
the derivative contracts and repo-style transactions in proportion to 
the respective product-specific exposure amounts. The respective 
product specific exposure amounts must be calculated, excluding the 
effects of collateral, according to Sec.  _.132(b) of the capital rule 
for repo-style transactions and to Sec.  _.132(c)(5) for derivative 
contracts.
    A clearing member banking organization also must calculate its 
capital requirement (KCMi), which is the capital requirement for its 
default fund contribution, subject to a floor equal to a 2 percent risk 
weight multiplied by the clearing member banking

[[Page 4393]]

organization's prefunded default fund contribution to the QCCP and an 8 
percent capital ratio. This calculation allocates KCCP on a 
pro rata basis to each clearing member based on the clearing member's 
share of the overall default fund contributions. Thus, a clearing 
member banking organization's capital requirement increases as its 
contribution to the default fund increases relative to the QCCP's own 
prefunded amounts and the total prefunded default fund contributions 
from all clearing members to the QCCP. In all cases, a clearing member 
banking organization's capital requirement for its default fund 
contribution to a QCCP may not exceed the capital requirement that 
would apply if the same exposure were calculated as if it were to a CCP 
that is not a QCCP.
    A clearing member banking organization calculates according to the 
following formula: \129\
---------------------------------------------------------------------------

    \129\ The agencies are clarifying that KCMi must be multiplied 
by 12.5 to arrive at the risk-weighted asset amount for a default 
fund contribution.
[GRAPHIC] [TIFF OMITTED] TR24JA20.011

---------------------------------------------------------------------------
Where:

KCCP is the hypothetical capital requirement of the QCCP;
DFpref is the prefunded default fund contribution of the 
clearing member banking organization to the QCCP;
DFCCP is the QCCP's own prefunded amounts (e.g., 
contributed capital, retained earnings) that are contributed to the 
default fund waterfall and are junior or pari passu to the default 
fund contribution of the members; and
DFCMpref is the total prefunded default fund 
contributions from clearing members of the QCCP.

V. Revisions to the Supplementary Leverage Ratio

    Under the capital rule, advanced approaches banking organizations 
and banking organizations subject to Category III standards must 
satisfy a minimum supplementary leverage ratio requirement of 3 
percent.\130\ The supplementary leverage ratio is the ratio of tier 1 
capital to total leverage exposure, where total leverage exposure 
includes both on-balance sheet assets and certain off-balance sheet 
exposures.\131\
---------------------------------------------------------------------------

    \130\ See 12 CFR 3.10(a)(5) (OCC); 12 CFR 217.10(a)(5) (Board); 
and 12 CFR 324.10(a)(5) (FDIC).
    \131\ See supra note 6.
---------------------------------------------------------------------------

    The proposal would have revised the capital rule to require 
advanced approaches banking organizations to use a modified version of 
SA-CCR, instead of CEM, to determine the on- and off-balance sheet 
amounts of derivative contracts for purposes of calculating total 
leverage exposure. The modified version of SA-CCR would have limited 
the recognition of collateral to certain cash variation margin \132\ in 
the replacement cost calculation, but would not have allowed for 
recognition of any financial collateral in the PFE component.\133\
---------------------------------------------------------------------------

    \132\ Consistent with CEM, the proposal would have permitted an 
advanced approaches banking organization to recognize cash variation 
margin in the on-balance component calculation only if (1) the cash 
variation margin met the conditions under Sec.  _.10(c)(4)(ii)(C)(3) 
through (7) of the proposed rule; and (2) it had not been recognized 
in the form of a reduction in the fair value of the derivative 
contracts within the netting set under the advanced approaches 
banking organization's operative accounting standard.
    \133\ To determine the carrying value of derivative contracts, 
U.S. GAAP provides a banking organization with the option to reduce 
any positive fair value of a derivative contract by the amount of 
any cash collateral received from the counterparty, provided the 
relevant GAAP criteria for offsetting are met (the GAAP offset 
option). Similarly, under the GAAP offset option, a banking 
organization has the option to offset the negative mark-to-fair 
value of a derivative contract with a counterparty. See Accounting 
Standards Codification paragraphs 815-10-45-1 through 7 and 210-20-
45-1. Under the capital rule, a banking organization that applies 
the GAAP offset option to determine the carrying value of its 
derivative contracts would be required to reverse the effect of the 
GAAP offset option for purposes of determining total leverage 
exposure, unless the collateral is cash variation margin recognized 
as settled with the derivative contract as a single unit of account 
for balance sheet presentation and satisfies the conditions under 
Sec.  _.10(c)(4)(ii)(C)(1)(ii) through (iii) and Sec.  
_.10(c)(4)(ii)(C)(3) through (7) of the capital rule.
---------------------------------------------------------------------------

    The proposal sought comment on whether the agencies should broaden 
the recognition of collateral in the supplementary leverage ratio to 
also include collateral provided by a client to a clearing member 
banking organization in connection with a cleared transaction (client 
collateral), in recognition of recent policy efforts to support 
migration of derivative transactions to CCPs, including an October 2018 
consultative release by the Basel Committee on the treatment of client 
collateral in the international leverage ratio standard.\134\ Several 
commenters urged the agencies to recognize greater amounts of client 
collateral, including margin, in either PFE or in both replacement cost 
and PFE. Other commenters, however, argued that the agencies should not 
recognize greater amounts of client collateral, including cash or non-
cash initial and variation margin, in connection with cleared 
transactions entered into on behalf of clients or any amount of margin 
collateral within the supplementary leverage ratio. In addition, some 
commenters urged the agencies to assess the effectiveness of collateral 
in offsetting the operational risks arising from the provision of 
client clearing services.
---------------------------------------------------------------------------

    \134\ See ``Consultative Document: Leverage ratio treatment of 
client cleared derivatives,'' Basel Committee on Banking Supervision 
(October 2018), https://www.bis.org/bcbs/publ/d451.pdf.
---------------------------------------------------------------------------

    Commenters that supported greater recognition of client collateral 
argued that such an approach would be consistent with the G20 mandate 
to establish policies that support the use of central clearing for 
derivative transactions,\135\ as it could decrease the regulatory 
capital cost of providing clearing services and thereby improve access 
to clearing services for clients, reduce concentration among clearing 
member banking organizations, and improve the portability of client 
positions to other clearing members, particularly in times of stress. 
Other commenters argued that allowing an advanced approaches banking 
organization to use the same SA-CCR methodology as proposed for the 
risk-based framework would simplify the capital rule for advanced 
approaches banking organizations.
---------------------------------------------------------------------------

    \135\ The Group of Twenty (G20) was established in 1999 to bring 
together industrialized and developing economies to discuss key 
issues in the global economy. Members include finance ministers and 
central bank governors from Argentina, Australia, Brazil, Canada, 
China, France, Germany, India, Indonesia, Italy, Japan, Mexico, 
Russia, Saudi Arabia, South Africa, Republic of Korea, Turkey, the 
United Kingdom, and the United States and the European Union. See 
``Leaders' Statement: The Pittsburgh Summit,'' G-20 (September 24-
25, 2009), https://www.treasury.gov/resource-center/international/g7-g20/Documents/pittsburgh_summit_leaders_statement_250909.pdf.
---------------------------------------------------------------------------

    Some commenters urged the agencies to consider the risk to 
financial stability if implementation of SA-CCR further exacerbates the 
trend towards concentration among clearing service providers or leads 
to a reduction in access to clearing for non-clearing-member entities. 
Of these, some commenters also argued that the proposed SA-CCR 
methodology could

[[Page 4394]]

indirectly adversely affect clearing member clients with directional 
and long-dated portfolios, such as pension funds, mutual funds, life 
insurance companies and other end-users that use derivatives largely 
for risk management purposes. Specifically, these commenters argued 
that such entities have already experienced difficulty in obtaining and 
maintaining access to central clearing from banking organizations due 
to the treatment of client margin, which substantially increases the 
capital requirements under the supplementary leverage ratio for banking 
organizations that provide clearing services.
    Other commenters argued that limiting the recognition of client 
collateral in the supplementary leverage ratio could have pro-cyclical 
effects that undermine the core objectives of the clearing framework. 
These commenters asserted that CCPs typically increase collateral 
requirements during stress periods, and therefore can cause clearing 
member banking organizations to be bound, or further bound, by the 
supplementary leverage ratio during that time. According to the 
commenters, procyclicality in the capital requirements for a clearing 
member could undermine the client-account portability objective of the 
central clearing framework if the clearing member is unable to acquire 
a book of cleared derivatives from another failing clearing member due 
to the regulatory capital costs of such acquisition.
    Furthermore, some commenters posited that greater recognition of 
the risk-reducing effects of client collateral for purposes of the 
supplementary leverage ratio would be appropriate due to the manner in 
which clearing member banking organizations collect such collateral and 
the protections such collateral receives under existing regulations. 
Specifically, these commenters noted that CFTC regulations prohibit 
rehypothecation of client collateral, and explicitly limit a clearing 
member banking organization's use of collateral received from a client 
to purposes that fulfil the clearing member's obligations to the CCP or 
to cover losses in the event of that client's default.
    By contrast, commenters who opposed greater recognition of the 
risk-reducing effects of client collateral under the supplementary 
leverage ratio expressed concern that such an approach would decrease 
capital levels among clearing member banking organizations and 
therefore could increase risks to both safety and soundness and U.S. 
financial stability. In particular, some commenters noted that solvency 
of clearing member banking organizations is critical to the stability 
of CCPs and that broadening the recognition of client collateral under 
the supplementary leverage ratio could undermine the advances made by 
central clearing mandates in stabilizing global financial markets. 
These commenters added that higher levels of regulatory capital at 
clearing member banking organizations could improve their ability to 
assume client positions from a defaulted clearing member in stress, and 
that the agencies have authority to provide temporary relief to 
leverage capital requirements if doing so would be necessary to allow a 
banking organization to absorb the client positions of an insolvent 
clearing member. With respect to concentration concerns, these 
commenters argued that lowering capital requirements for clearing 
member banking organizations would not reduce concentration in the 
provision of clearing services; rather, any further reduction in 
capital requirements for clearing member banking organizations would 
only benefit banking organizations that already provide these services. 
In addition, these commenters expressed concern regarding the 
introduction of risk mitigants into the leverage capital requirements, 
and stated that such a revision could blur the distinction between 
leverage and risk-based capital requirements.
    The final rule allows a clearing member banking organization to 
recognize the risk-reducing effect of client collateral in replacement 
cost and PFE for purposes of calculating total leverage exposure under 
certain circumstances.\136\ This treatment applies to a banking 
organization's exposure to its client-facing derivative transactions. 
For such exposures, the banking organization would use SA-CCR, as 
applied for risk-based capital purposes, which permits recognition of 
both cash and non-cash margin received from a client in replacement 
cost and PFE. The agencies believe that this treatment appropriately 
recognizes recent developments in the use of central clearing and 
maintains levels of capital consistent with safe and sound operations 
of banking organizations engaged in these activities. Although there 
are some risks associated with CCPs, the agencies believe that central 
clearing through CCPs generally reduces the effective exposure of 
derivative contracts through the multilateral netting of exposures, 
establishment and enforcement of collateral requirements, and promotion 
of market transparency. Also, this treatment is consistent with the G20 
mandate to establish policies that support the use of central clearing, 
and recent developments by the Basel Committee. Specifically, on June 
26, 2019, the Basel Committee released a standard that revises the 
leverage ratio treatment of client-cleared derivatives contracts to 
generally align with the measurement of such exposures under SA-CCR as 
used for risk-based capital purposes.\137\ The standard was designed to 
balance the robustness of the supplementary leverage ratio as a non-
risk-based safeguard against unsustainable sources of leverage with the 
policy objective set by G20 leaders to promote central clearing of 
standardized derivative contracts as part of mitigating systemic risk 
and making derivative markets safer. The final rule similarly maintains 
the complementary purpose of risk-based and leverage capital 
requirements, in a manner that is expected to have minimal impact on 
overall capital levels, will reduce burden by reducing the number of 
separate calculations required, and will not impede important policy 
objectives regarding central clearing.
---------------------------------------------------------------------------

    \136\ The recognition of client collateral provided under the 
final rule only applies in the context of SA-CCR, not CEM.
    \137\ See supra note 20.
---------------------------------------------------------------------------

    Banking organizations subject to the supplementary leverage ratio 
under Category III that continue to use CEM to determine the total 
leverage exposure measure are not permitted to recognize the risk-
reducing effects of client collateral other than with respect to 
certain transfers of cash variation margin in replacement cost. 
Relative to CEM, SA-CCR is more sensitive to the recognition of 
collateral, and therefore the commenters' concerns are more pronounced 
in that context. Moreover, most clearing member banking organizations 
are advanced approaches banking organizations that are required to use 
SA-CCR or IMM for the cleared transactions framework, and extending 
such treatment to CEM would have limited impact, if any, in the 
aggregate.
    Some commenters noted that section 34 of the capital rule allows a 
banking organization subject to the supplementary leverage ratio to 
exclude the PFE of all credit derivatives or other similar instruments 
through which it provides credit protection, but without regard to 
credit risk mitigation, provided that it does not adjust the net-to-
gross ratio. Under the capital rule, a banking organization subject to 
the supplementary leverage ratio that chooses to exclude the PFE of 
credit derivatives or other similar instruments through which it 
provides credit

[[Page 4395]]

protection must do so consistently over time for the calculation of the 
PFE for all such instruments. The agencies are clarifying that the same 
treatment would apply under SA-CCR for purposes of the supplementary 
leverage ratio.\138\ In particular, a banking organization subject to 
the supplementary leverage ratio may choose to exclude from the PFE 
component of the exposure amount calculation the portion of a written 
credit derivative that is not offset according to Sec.  
_.10(c)(4)(ii)(D)(1)-(2) and for which the effective notional amount of 
the written credit derivative is included in total leverage exposure.
---------------------------------------------------------------------------

    \138\ See 79 FR 57725, 57731-57732 (Sept. 26, 2014).
---------------------------------------------------------------------------

    The agencies generally are adopting as final the proposed 
requirement that a banking organization that is required to use SA-CCR 
or elects to use SA-CCR to calculate the exposure amount of its 
derivative contracts for purposes of the supplementary leverage ratio 
must use the modified version of SA-CCR described in Sec.  
_.10(c)(4)(ii) of the final rule, with a few revisions.\139\ For a 
client-facing derivative transaction, however, the banking organization 
calculates the exposure amount under Sec.  _.132(c)(5).
---------------------------------------------------------------------------

    \139\ Some commenters requested clarification regarding the 
items to be summed under Sec.  _.10(c)(4)(ii)(C)(1) of the proposed 
rule. The agencies are clarifying that the items to be summed under 
this paragraph (now located at Sec.  _.10(c)(4)(ii)(C)(2)(i) of the 
final rule) are the replacement cost of each derivative contract or 
single product netting set of derivative contracts to which the 
advanced approaches banking organization is a counterparty, as 
described under 10(c)(4)(ii)(C)(2)(i) of the final rule. Section 
_.10(c)(4)(ii)(C)(2)(ii) of the final rule serves to adjust, under 
certain situations, the items to be summed under Sec.  
_.10(c)(4)(ii)(C)(2)(i). In addition, these commenters requested 
clarification of the application of Sec.  _.10(c)(4)(ii)(C)(2) in 
the proposal. The agencies are removing Sec.  _.10(c)(4)(ii)(C)(2) 
from the final rule, as this provision is captured under the 
definition of the cash variation margin terms in the formula 
described under Sec.  _.10(c)(4)(ii)(C)(2)(i).
---------------------------------------------------------------------------

    Consistent with the proposal, written options must be included in 
total leverage exposure even though the final rule allows certain 
written options to receive an exposure amount of zero for risk-based 
capital purposes.\140\
---------------------------------------------------------------------------

    \140\ Under the final rule, the exposure amount of a netting set 
that consists of only sold options in which the premiums have been 
fully paid by the counterparty to the options and where the options 
are not subject to a variation margin agreement is zero. See section 
III.A. of this Supplementary Information for further discussion.
---------------------------------------------------------------------------

VI. Technical Amendments

    The proposal would have made several technical corrections and 
clarifications to the capital rule to address certain provisions that 
warrant revision based on questions presented by banking organizations 
and further review by the agencies. The agencies did not receive 
comment on these technical amendments, and are finalizing them as 
proposed. The agencies did receive several suggestions for other 
clarifications and technical changes to the proposal. The agencies are 
adopting many of these suggestions in the final rule. These changes are 
described below.

A. Receivables Due From a QCCP

    The final rule revises Sec.  _.32 of the capital rule to clarify 
that cash collateral posted by a clearing member banking organization 
to a QCCP, and which could be considered a receivable due from the QCCP 
under U.S. GAAP, should not be risk-weighted as a corporate exposure. 
Instead, for a client-cleared trade the cash collateral posted to a 
QCCP receives a risk weight of 2 percent, if the cash associated with 
the trade meets the requirements under Sec.  _.35(b)(3)(i)(A) or Sec.  
_.133(b)(3)(i)(A) of the capital rule, or 4 percent, if the collateral 
does not meet the requirements necessary to receive the 2 percent risk 
weight. For a trade made on behalf of the clearing member's own 
account, the cash collateral posted to a QCCP receives a 2 percent risk 
weight. The agencies intend for this amendment to maintain incentives 
for banking organizations to post cash collateral and recognize that a 
receivable from a QCCP that arises in the context of a trade exposure 
should not be treated as equivalent to a receivable that would arise 
if, for example, a banking organization made a loan to a CCP.

B. Treatment of Client Financial Collateral Held by a CCP

    Under Sec.  _.2 of the capital rule, financial collateral means, in 
part, collateral in which a banking organization has a perfected first-
priority security interest in the collateral. However, when a banking 
organization is acting on behalf of a client, it generally is required 
to post any client collateral to the CCP, in which case the CCP 
establishes and maintains a perfected first-priority security interest 
in the collateral instead of the clearing member. As a result, the 
capital rule does not permit a clearing member banking organization to 
recognize client collateral posted to a CCP as financial collateral.
    Client collateral posted to a CCP remains available to mitigate the 
risk of a credit loss on a derivative contract in the event of a client 
default. Specifically, when a client defaults the CCP will use the 
client collateral to offset its exposure to the client, and the 
clearing member banking organization would be required to cover only 
the amount of any deficiency between the liquidation value of the 
collateral and the CCP's exposure to the client. However, were the 
clearing member banking organization to enter into the derivative 
contract directly with the client, the clearing member would establish 
and maintain a perfected first-priority security interest in the 
collateral, and the exposure of the clearing member to the client would 
similarly be mitigated only to the extent the collateral is sufficient 
to cover the exposure amount of the transaction at the time of default. 
Therefore, the final rule revises the definition of financial 
collateral to allow clearing member banking organizations to recognize 
as financial collateral noncash client collateral posted to a CCP. In 
this situation, the clearing member banking organization is not 
required to establish and retain a first-priority security interest in 
the collateral for it to qualify as financial collateral under Sec.  
_.2 of the capital rule.

C. Clearing Member Exposure When CCP Performance Is Not Guaranteed

    The final rule revises Sec.  _.35(c)(3) of the capital rule to 
align the capital requirements under the standardized approach for 
client-cleared transactions with the treatment under Sec.  _.133(c)(3) 
of the advanced approaches. Specifically, the final rule allows a 
clearing member banking organization that does not guarantee the 
performance of the CCP to the clearing member's client to apply a zero 
percent risk weight to the CCP-facing portion of the transaction. The 
agencies previously implemented this treatment for purposes of the 
advanced approaches.\141\
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    \141\ See 80 FR 41411 (July 15, 2015).
---------------------------------------------------------------------------

D. Bankruptcy Remoteness of Collateral

    The final rule removes the requirement in Sec.  _.35(b)(4)(i) of 
the standardized approach and Sec.  _.133(b)(4)(i) of the advanced 
approaches that collateral posted by a clearing member client banking 
organization to a clearing member banking organization must be 
bankruptcy remote from a custodian in order for the client banking 
organization to avoid the application of risk-based capital 
requirements related to the collateral, and clarifies that a custodian 
must be acting in its capacity as a custodian for this treatment to 
apply.\142\

[[Page 4396]]

The agencies believe this revision is appropriate because the 
collateral would generally be considered to be bankruptcy remote if the 
custodian is acting in its capacity as a custodian with respect to the 
collateral. Therefore, this revision applies only in cases where the 
collateral is deposited with a third-party custodian, not in cases 
where a clearing member banking organization offers ``self-custody'' 
arrangements with its clients. In addition, this revision makes the 
collateral requirement for a clearing member client banking 
organization consistent with the treatment of collateral posted by a 
clearing member banking organization, which does not require that the 
posted collateral be bankruptcy remote from the custodian, but requires 
in each case that the custodian be acting in its capacity as a 
custodian.
---------------------------------------------------------------------------

    \142\ See 12 CFR 3.35(b)(4) and 3.133(b)(4) (OCC); 12 CFR 
217.35(b)(4) and 217.133(b)(4) (Board); and 12 CFR 324.35(b)(4) and 
324.133(b)(4) (FDIC).
---------------------------------------------------------------------------

E. Adjusted Collateral Haircuts for Derivative Contracts

    For a cleared transaction, the clearing member banking organization 
must determine the exposure amount for the client-facing derivative 
transaction of the derivative contract using the collateralized 
transactions framework under Sec.  _.37(c)(3) of the capital rule or 
the counterparty credit risk framework under Sec.  _.132(b)(2)(ii) of 
the capital rule. The clearing member banking organization may 
recognize the credit risk-mitigation benefits of the collateral posted 
by the client; however, under Sec. Sec.  _.37(c) and _.132(b) of the 
capital rule, the value of the collateral must be discounted by the 
application of a standard supervisory haircut to reflect any market 
price volatility in the value of the collateral over a ten-business-day 
holding period. For a repo-style transaction, the capital rule applies 
a scaling factor of the square root of \1/2\ (which equals 0.707107) to 
the standard supervisory haircuts to reflect the limited risk to 
collateral in those transactions and effectively reduce the holding 
period to five business days. The proposal would have provided a 
similar reduction in the haircuts for client-facing derivative 
transactions, as they typically have a holding period of less than ten 
business days. Some commenters requested clarification whether a five-
business-day holding period would apply for the purpose of calculating 
collateral haircuts for client-facing derivatives under Sec.  
_.132(b)(2)(ii)(A)(3) of the proposal. The final rule revises 
Sec. Sec.  _.37(c)(3)(iii) and _.132(b)(2)(ii)(A)(3) of the capital 
rule to adjust the holding period for client-facing derivative 
transactions by applying a scaling factor of 0.71, which represents a 
five-business-day holding period. The final rule also requires a 
banking organization to use a larger scaling factor for collateral 
haircuts for client-facing derivatives when it determines a holding 
period longer than five days is appropriate.

F. OCC Revisions to Lending Limits

    The OCC proposed to revise its lending limit rule at 12 CFR part 
32. The current lending limits rule references sections of CEM in the 
OCC's advanced approaches capital rule as one available methodology for 
calculating exposures to derivatives transactions. However, these 
sections were proposed to be amended or replaced with SA-CCR in the 
advanced approaches. Therefore, the OCC proposed to replace the 
references to CEM in the advanced approaches with references to CEM in 
the standardized approach. The OCC also proposed to adopt SA-CCR as an 
option for calculation of exposures under lending limits.
    The agencies received two comments supporting the OCC's proposal to 
use SA-CCR to measure counterparty credit risk under both the capital 
rules and other agency rules, including lending limits, as creating 
less burden on institutions. The OCC agrees that it would be less 
burdensome for institutions to use similar methodologies to measure 
counterparty credit risk across OCC regulations, and therefore are 
finalizing these revisions to the lending limits rule as proposed.

G. Other Clarifications and Technical Amendments From the Proposal to 
the Final Rule

    Some commenters suggested that the agencies make a revision to the 
approaches for calculating capital requirements regarding CVAs under 
Sec.  _.132(e). Under the final rule, the agencies are clarifying that 
for purposes of calculating the CVA capital requirements under Sec.  
_.132(e)(5)(i)(C), (e)(6)(i)(B) and (e)(6)(viii), an advanced 
approaches banking organization must use SA-CCR instead of CEM where 
CEM was provided as an option. In addition, the final rule revises the 
definition of CEM in Sec.  _.2 to refer to Sec.  _.34(b) instead of 
Sec.  _.34(a).

VII. Impact of the Final Rule

    For the proposal, the agencies reviewed data provided by advanced 
approaches banking organizations that represent a significant majority 
of the derivatives market. In particular, the agencies analyzed the 
change in exposure amount between CEM and SA-CCR, as well as the change 
in risk-weighted assets as determined under the standardized 
approach.\143\ The data cover diverse portfolios of derivative 
contracts, both in terms of asset type and counterparty. In addition, 
the data include firms that serve as clearing members, allowing the 
agencies to consider the effect of the proposal under the cleared 
transactions framework for both a direct exposure to a CCP and a 
clearing member's exposure to its client with respect to client-facing 
derivative transactions. As a result, the analysis provides a 
reasonable proxy for the potential changes for all advanced approaches 
banking organizations.
---------------------------------------------------------------------------

    \143\ The agencies estimated that, on aggregate, exposure 
amounts under SA-CCR would equal approximately 170 percent of the 
exposure amounts for identical derivative contracts under IMM. Thus, 
firms that use IMM currently would likely continue to use IMM to 
determine the exposure amount of their derivative contracts to 
determine advanced approaches total risk-weighted assets. However, 
the standardized approach serves as a floor on advanced approaches 
banking organizations' total risk-weighted assets. Thus, a firm 
would only receive the benefit of IMM if the firm is not bound by 
standardized total risk-weighted assets.
---------------------------------------------------------------------------

    The agencies estimated that, under the proposal, the exposure 
amount for derivative contracts held by advanced approaches banking 
organizations would have decreased by approximately 7 percent. The 
agencies also estimated that the proposal would have resulted in an 
approximately 5 percent increase in advanced approaches banking 
organizations' standardized risk-weighted assets associated with 
derivative contract exposures.\144\ In addition, the proposal would 
have resulted in an increase (approximately 30 basis points) in 
advanced approaches banking organizations' supplementary leverage 
ratios, on average.
---------------------------------------------------------------------------

    \144\ Total risk-weighted assets are a function of the exposure 
amount of the netting set and the applicable risk-weight of the 
counterparty. Total risk-weighted assets increase under the analysis 
while exposure amounts decrease because higher applicable risk 
weights amplify increases in the exposure amount of certain 
derivative contracts, which outweighs decreases in the exposure 
amount of other derivative contracts.
---------------------------------------------------------------------------

    The agencies made several changes to the SA-CCR methodology for the 
final rule that could have a material effect on the impact of the final 
rule. First, the final rule changes certain of the supervisory factors 
for commodity derivative contracts to coincide with the supervisory 
factors in the Basel Committee standard.\145\ Second, the

[[Page 4397]]

final rule removes the alpha factor for exposures to commercial end-
users. Third, the final rule allows a banking organization to treat 
settled-to-market derivative contracts as subject to a variation margin 
agreement, allowing such contracts to net with collateralized-to-market 
derivative contracts of the same netting set. Lastly, the final rule 
allows clearing member banking organizations to recognize client 
collateral under the supplementary leverage ratio, to the same extent a 
banking organization may recognize collateral for risk-based capital 
purposes.
---------------------------------------------------------------------------

    \145\ The change in the supervisory factors for commodity 
derivative contracts will not result in a change in the agencies 
initial estimate of the impact of the final rule. This is because 
the data received from the advanced approach banking organizations 
already reflected the supervisory factors for commodity derivative 
contracts included in the Basel Standard, and the agencies did not 
adjust the data to account for the proposed 40 percent supervisory 
factor for all energy derivative contracts.
---------------------------------------------------------------------------

    Using the same data set as used for the proposal, the agencies 
found that the exposure amount for derivative contracts held by 
advanced approaches banking organizations will decrease by 
approximately 9 percent under the final rule. Generally speaking, 
exposure amounts for interest rate, credit and foreign exchange 
derivatives would be expected to decrease, and exposure amounts for 
equities and commodities would be expected to increase. The agencies 
estimate that the final rule will result in an approximately 4 percent 
decrease in advanced approaches banking organizations' standardized 
risk-weighted assets associated with derivative contract exposures and 
that the final rule will result in an increase (approximately 37 basis 
points) in advanced approaches banking organizations' reported 
supplementary leverage ratios, on average. While too much precision 
should not be attached to estimates regarding individual banking 
organizations owing to variations in data quality, estimated changes in 
individual banking organizations' supplementary leverage ratios range 
from -5 basis points to 85 basis points.
    In the proposal, the agencies found that the effects of the 
proposed rule likely would be limited for non-advanced approaches 
banking organizations. First, these banking organizations hold 
relatively small derivative portfolios. Non-advanced approaches banking 
organizations account for less than 9 percent of derivative contracts 
of all banking organizations, even though they account for roughly 36 
percent of total assets of all banking organizations.\146\ Second, 
nearly all non-advanced approaches banking organizations are not 
subject to supplementary leverage ratio requirements, and thus would 
not be affected by any changes to the calculation of total leverage 
exposure. These banking organizations retain the option of using CEM, 
including for the supplementary leverage ratio, if applicable, and the 
agencies anticipate that only those banking organizations that receive 
a material net benefit from using SA-CCR would elect to use it. 
Therefore, the agencies continue to find that the impact on non-
advanced approaches banking organizations under the final rule would be 
limited.
---------------------------------------------------------------------------

    \146\ According to data from the Consolidated Reports of 
Condition and Income for a Bank with Domestic and Foreign Offices 
(FFIEC report forms 031, 041, and 051), as of March 31, 2018.
---------------------------------------------------------------------------

VIII. Regulatory Analyses

A. Paperwork Reduction Act

    The agencies' regulatory capital rule contains ``collections of 
information'' within the meaning of the Paperwork Reduction Act (PRA) 
of 1995 (44 U.S.C. 3501-3521). In accordance with the requirements of 
the PRA, the agencies may not conduct or sponsor, and the respondent is 
not required to respond to, an information collection unless it 
displays a currently-valid Office of Management and Budget (OMB) 
control number. The OMB control number for the OCC is 1557-0318, Board 
is 7100-0313, and FDIC is 3064-0153. The information collections that 
are part of the agencies' regulatory capital rule will not be affected 
by this final rule and therefore no final submissions will be made by 
the FDIC or OCC to OMB under section 3507(d) of the PRA (44 U.S.C. 
3507(d)) or section 1320.11 of the OMB's implementing regulations (5 
CFR 1320) in connection with this rulemaking.\147\
---------------------------------------------------------------------------

    \147\ The OCC and FDIC submitted their information collections 
to OMB at the proposed rule stage. However, these submissions were 
done solely in an effort to apply a conforming methodology for 
calculating the burden estimates and not due to the proposed rule. 
OMB filed comments requesting that the agencies examine public 
comment in response to the proposed rule and describe in the 
supporting statement of its next collection any public comments 
received regarding the collection as well as why (or why it did not) 
incorporate the commenters' recommendation. In addition, OMB 
requested that the OCC and the FDIC note the convergence of the 
agencies on the single methodology. The agencies received no 
comments on the information collection requirements. Since the 
proposed rule stage, the agencies have conformed their respective 
methodologies in a separate final rulemaking titled, ``Regulatory 
Capital Rule: Implementation and Transition of the Current Expected 
Credit Losses Methodology for Allowances and Related Adjustments to 
the Regulatory Capital Rule and Conforming Amendments to Other 
Regulations,'' 84 FR 4222 (February 14, 2019), and have had their 
submissions approved through OMB. As a result, the agencies 
information collections related to the regulatory capital rules are 
currently aligned and therefore no submission will be made to OMB.
---------------------------------------------------------------------------

    As a result of this final rule, the agencies have proposed to 
clarify the reporting instructions for the Consolidated Reports of 
Condition and Income (Call Reports) (FFIEC 031, FFIEC 041, and FFIEC 
051) and Regulatory Capital Reporting for Institutions Subject to the 
Advanced Capital Adequacy Framework (FFIEC 101).\148\ The OCC and FDIC 
expect to clarify the reporting instructions for DFAST 14A, and the 
Board expects to clarify the reporting instructions for the 
Consolidated Financial Statements for Holding Companies (FR Y-9C), 
Capital Assessments and Stress Testing (FR Y-14A and FR Y-14Q), and 
Banking Organization Systemic Risk Report (FR Y-15) as appropriate to 
reflect the changes to the regulatory capital rule related to this 
final rule.
---------------------------------------------------------------------------

    \148\ See 84 FR 53227 (October 4, 2019).
---------------------------------------------------------------------------

B. Regulatory Flexibility Act

    OCC: The Regulatory Flexibility Act, 5 U.S.C. 601 et seq. (RFA), 
requires an agency, in connection with a final rule, to prepare a Final 
Regulatory Flexibility Analysis describing the impact of the rule on 
small entities (defined by the Small Business Administration (SBA) for 
purposes of the RFA to include commercial banks and savings 
institutions with total assets of $600 million or less and trust 
companies with total revenue of $41.5 million or less) or to certify 
that the final rule would not have a significant economic impact on a 
substantial number of small entities. As of December 31, 2018, the OCC 
supervised 782 small entities. The rule would impose requirements on 
all OCC supervised entities that are subject to the advanced approaches 
risk-based capital rules, which typically have assets in excess of $250 
billion, and therefore would not be small entities. While small 
entities would have the option to adopt SA-CCR, the OCC does not expect 
any small entities to elect that option. Therefore, the OCC estimates 
the final rule would not generate any costs for small entities. 
Therefore, the OCC certifies that the final rule would not have a 
significant economic impact on a substantial number of OCC-supervised 
small entities.
    FDIC: The RFA generally requires that, in connection with a final 
rulemaking, an agency prepare and make available for public comment a 
final regulatory flexibility analysis describing the impact of the rule 
on small entities.\149\ However, a regulatory flexibility analysis is 
not required if the agency certifies that the final rule will not have 
a significant economic impact on a substantial number of small 
entities. The SBA has defined ``small entities'' to include banking

[[Page 4398]]

organizations with total assets of less than or equal to $600 million 
that are independently owned and operated or owned by a holding company 
with less than or equal to $600 million in total assets.\150\ 
Generally, the FDIC considers a significant effect to be a quantified 
effect in excess of 5 percent of total annual salaries and benefits per 
institution, or 2.5 percent of total non-interest expenses. The FDIC 
believes that effects in excess of these thresholds typically represent 
significant effects for FDIC-supervised institutions.
---------------------------------------------------------------------------

    \149\ 5 U.S.C. 601 et seq.
    \150\ The SBA defines a small banking organization as having 
$600 million or less in assets, where an organization's ``assets are 
determined by averaging the assets reported on its four quarterly 
financial statements for the preceding year.'' See 13 CFR 121.201 
(as amended by 84 FR 34261, effective August 19, 2019). In its 
determination, the ``SBA counts the receipts, employees, or other 
measure of size of the concern whose size is at issue and all of its 
domestic and foreign affiliates.'' See 13 CFR 121.103. Following 
these regulations, the FDIC uses a covered entity's affiliated and 
acquired assets, averaged over the preceding four quarters, to 
determine whether the covered entity is ``small'' for the purposes 
of RFA.
---------------------------------------------------------------------------

    For the reasons described below, the FDIC believes that the final 
rule will not have a significant economic impact on a substantial 
number of small entities. Nevertheless, the FDIC has conducted and is 
providing a final regulatory flexibility analysis.
1. The Need for, and Objectives of, the Rule
    The policy objective of the final rule is to provide a new and more 
risk-sensitive methodology for calculating the exposure amount for 
derivative contracts. SA-CCR will replace the existing CEM methodology 
for advanced approaches institutions. Non-advanced approaches banking 
organizations will have the option of using SA-CCR in place of CEM.
2. The Significant Issues Raised by the Public Comments in Response to 
the Initial Regulatory Flexibility Analysis
    No significant issues were raised by the public comments in 
response to the initial regulatory flexibility analysis.
3. Response of the Agency to Any Comments Filed by the Chief Counsel 
for Advocacy of the Small Business Administration in Response to the 
Proposed Rule
    No comments were filed by the Chief Counsel for Advocacy of the 
Small Business Administration in response to the proposed rule.
4. A Description of and an Estimate of the Number of Small Entities to 
Which the Rule Will Apply or an Explanation of Why no Such Estimate Is 
Available
    As of June 30, 2019, the FDIC supervised 3,424 institutions, of 
which 2,665 are considered small entities for the purposes of RFA. 
These small IDIs hold $514 billion in assets, accounting for 16.6 
percent of total assets held by FDIC-supervised institutions.\151\
---------------------------------------------------------------------------

    \151\ Consolidated Reports of Condition and Income for the 
quarter ending June 30, 2019.
---------------------------------------------------------------------------

    The final rule will require advanced approaches institutions to use 
either SA-CCR or IMM to calculate the exposure amount of its noncleared 
and cleared derivative contracts under the advanced approaches. For 
purposes of determining the exposure amount of its noncleared and 
cleared derivative contracts under the standardized approach, an 
advanced approaches institution must use SA-CCR. An advanced approaches 
institution must use SA-CCR to determine the risk-weighted asset amount 
of its default fund contributions under both the approaches. There are 
no FDIC-supervised advanced approaches institutions that are considered 
small entities for the purposes of RFA.\152\
---------------------------------------------------------------------------

    \152\ Id.
---------------------------------------------------------------------------

    The final rule will allow, but not require, non-advanced approaches 
institutions to replace CEM with SA-CCR as the approach for calculating 
EAD. While this allowance applies to all 2,665 small entities, only 401 
(15 percent) report holding any volume of derivatives and would 
therefore be affected by differences between CEM and SA-CCR. These 401 
banks' holdings of derivatives account for only 7.6 percent of their 
assets, so the effects of calculating the exposure amount of 
derivatives using SA-CCR on their capital requirements would likely be 
insignificant.\153\ Since adoption of SA-CCR is optional, these banks 
would weigh the benefits of SA-CCR adoption against its costs. Given 
that SA-CCR adoption necessitates internal systems enhancements and 
other operational modifications that could be particularly burdensome 
for smaller, less complex banking organizations, the FDIC expects that 
no small institutions will likely adopt SA-CCR.
---------------------------------------------------------------------------

    \153\ Id.
---------------------------------------------------------------------------

5. A Description of the Projected Reporting, Recordkeeping and Other 
Compliance Requirements of the Rule
    No small entity will be compelled to use SA-CCR, so the rule does 
not impose any reporting, recordkeeping and other compliance 
requirements onto small entities.
    The FDIC does not expect any small entity to adopt SA-CCR, given 
the internal systems enhancements and operational modifications needed 
for SA-CCR adoption. A small institution will elect to use SA-CCR only 
if the net benefits of doing so are positive. Thus, the FDIC expects 
the proposed rule will not impose any net economic costs on these 
entities.
6. A Description of the Steps the Agency Has Taken To Minimize the 
Significant Economic Impact on Small Entities
    As described above, the FDIC does not believe this rule will have a 
significant economic impact on a substantial number of small entities. 
Further, since adopting SA-CCR is voluntary, only entities that expect 
to benefit from SA-CCR will adopt it.
    Board: An initial regulatory flexibility analysis (IRFA) was 
included in the proposal in accordance with section 603(a) of the 
Regulatory Flexibility Act (RFA), 5 U.S.C. 601 et seq. In the IRFA, the 
Board requested comment on the effect of the proposed rule on small 
entities and on any significant alternatives that would reduce the 
regulatory burden on small entities. The Board did not receive any 
comments on the IRFA. The RFA requires an agency to prepare a final 
regulatory flexibility analysis unless the agency certifies that the 
rule will not, if promulgated, have a significant economic impact on a 
substantial number of small entities. Based on its analysis, and for 
the reasons stated below, the Board certifies that the rule will not 
have a significant economic impact on a substantial number of small 
entities.\154\
---------------------------------------------------------------------------

    \154\ 5 U.S.C. 605(b).
---------------------------------------------------------------------------

    Under regulations issued by the Small Business Administration, a 
small entity includes a bank, bank holding company, or savings and loan 
holding company with assets of $600 million or less and trust companies 
with total assets of $41.5 million or less (small banking 
organization).\155\ As of June 30, 2019, there were approximately 2,976 
small bank holding companies, 133 small savings and loan holding 
companies, and 537 small SMBs.
---------------------------------------------------------------------------

    \155\ See 13 CFR 121.201. Effective August 19, 2019, the SBA 
revised the size standards for banking organizations to $600 million 
in assets from $550 million in assets. 84 FR 34261 (July 18, 2019).
---------------------------------------------------------------------------

    As discussed in the SUPPLEMENTARY INFORMATION section, the final 
rule revises the capital rule to provide a new and more risk-sensitive 
methodology for calculating the exposure amount for derivative 
contracts. For purposes of

[[Page 4399]]

calculating advanced approaches total risk-weighted assets, an advanced 
approaches Board-regulated institution may use either SA-CCR or the 
internal models methodology. For purposes of calculating standardized 
total risk-weighted assets, an advanced approaches Board-regulated 
institution must use SA-CCR and a non-advanced approaches Board-
regulated institution may elect either SA-CCR or CEM.\156\ In addition, 
for purposes of the denominator of the supplementary leverage ratio, 
the final rule integrates SA-CCR into the calculation of the 
denominator, replacing CEM.\157\
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    \156\ Advanced approaches banking organizations include 
depository institutions, bank holding companies, savings and loan 
holding companies, or intermediate holding companies subject to 
Category I or Category II standards. See supra note 23.
    \157\ In general, the Board's capital rule only applies to bank 
holding companies and savings and loan holding companies that are 
not subject to the Board's Small Bank Holding Company and Savings 
and Loan Holding Company Policy Statement, which applies to bank 
holding companies and savings and loan holding companies with less 
than $3 billion in total assets that also meet certain additional 
criteria. In addition, the agencies recently adopted a final rule to 
implement a community bank leverage ratio framework that is 
applicable, on an optional basis to depository institutions and 
depository institution holding companies with less than $10 billion 
in total consolidated assets and that meet certain other criteria. 
Such banking organizations that opt into the community bank leverage 
ratio framework will be deemed compliant with the capital rule's 
generally applicable requirements and are not required to calculate 
risk-based capital ratios. See supra note 3. Very few bank holding 
companies and savings and loan holding companies that are small 
entities would be impacted by the final rule because very few such 
entities are subject to the Board's capital rule.
---------------------------------------------------------------------------

    The Board does not expect that the final rule will result in a 
material change in the level of capital maintained by small banking 
organizations or in the compliance burden on small banking 
organizations because the framework is optional for non-advanced 
approaches banking organizations. To the extent that small banking 
organizations elect to adopt SA-CCR because it provides advantageous 
regulatory capital treatment of derivatives, any implementation costs 
or increased compliance costs associated with SA-CCR should be 
outweighed by the capital impact of SA-CCR. In any event, small banking 
organizations generally do not have substantial portfolios of 
derivative contracts and therefore any impact of SA-CCR on capital 
requirements is expected to be minimal. For these reasons, the Board 
does not expect the rule to have a significant economic impact on a 
substantial number of small entities.

C. Plain Language

    Section 722 of the Gramm-Leach-Bliley Act \158\ requires the 
Federal banking agencies to use plain language in all proposed and 
final rules published after January 1, 2000. The agencies have sought 
to present the final rule in a simple and straightforward manner, and 
did not receive comment on the use of plain language.
---------------------------------------------------------------------------

    \158\ See Public Law 106-102, section 722, 113 Stat. 1338, 1471 
(1999).
---------------------------------------------------------------------------

D. Riegle Community Development and Regulatory Improvement Act of 1994

    Pursuant to section 302(a) of the Riegle Community Development and 
Regulatory Improvement Act (RCDRIA),\159\ in determining the effective 
date and administrative compliance requirements for new regulations 
that impose additional reporting, disclosure, or other requirements on 
IDIs, each Federal banking agency must consider, consistent with 
principles of safety and soundness and the public interest, any 
administrative burdens that such regulations would place on depository 
institutions, including small depository institutions, and customers of 
depository institutions, as well as the benefits of such regulations. 
In addition, section 302(b) of RCDRIA requires new regulations and 
amendments to regulations that impose additional reporting, 
disclosures, or other new requirements on IDIs generally to take effect 
on the first day of a calendar quarter that begins on or after the date 
on which the regulations are published in final form.\160\
---------------------------------------------------------------------------

    \159\ 12 U.S.C. 4802(a).
    \160\ 12 U.S.C. 4802.
---------------------------------------------------------------------------

    In accordance with these provisions of RCDRIA, the agencies 
considered any administrative burdens, as well as benefits, that the 
final rule would place on depository institutions and their customers 
in determining the effective date and administrative compliance 
requirements of the final rule. In conjunction with the requirements of 
RCDRIA, the final rule is effective on April 1, 2020.

E. OCC Unfunded Mandates Reform Act of 1995 Determination

    The OCC analyzed the proposed rule under the factors set forth in 
the Unfunded Mandates Reform Act of 1995 (UMRA) (2 U.S.C. 1532). Under 
this analysis, the OCC considered whether the final rule includes a 
Federal mandate that may result in the expenditure by State, local, and 
Tribal governments, in the aggregate, or by the private sector, of $100 
million or more in any one year (adjusted for inflation). The OCC has 
determined that this final rule would not result in expenditures by 
State, local, and Tribal governments, or the private sector, of $100 
million or more in any one year. Accordingly, the OCC has not prepared 
a written statement to accompany this proposal.

F. The Congressional Review Act

    For purposes of Congressional Review Act, the OMB makes a 
determination as to whether a final rule constitutes a ``major'' 
rule.\161\ If a rule is deemed a ``major rule'' by the OMB, the 
Congressional Review Act generally provides that the rule may not take 
effect until at least 60 days following its publication.\162\
---------------------------------------------------------------------------

    \161\ 5 U.S.C. 801 et seq.
    \162\ 5 U.S.C. 801(a)(3).
---------------------------------------------------------------------------

    The Congressional Review Act defines a ``major rule'' as any rule 
that the Administrator of the Office of Information and Regulatory 
Affairs of the OMB finds has resulted in or is likely to result in--(A) 
an annual effect on the economy of $100,000,000 or more; (B) a major 
increase in costs or prices for consumers, individual industries, 
Federal, State, or local government agencies or geographic regions, or 
(C) significant adverse effects on competition, employment, investment, 
productivity, innovation, or on the ability of United States-based 
enterprises to compete with foreign-based enterprises in domestic and 
export markets.\163\ As required by the Congressional Review Act, the 
agencies will submit the final rule and other appropriate reports to 
Congress and the Government Accountability Office for review.
---------------------------------------------------------------------------

    \163\ 5 U.S.C. 804(2).
---------------------------------------------------------------------------

List of Subjects

12 CFR Part 3

    Administrative practice and procedure, Capital, National banks, 
Risk.

12 CFR Part 32

    National banks, Reporting and recordkeeping requirements.

12 CFR Part 217

    Administrative practice and procedure, Banks, Banking, Capital, 
Federal Reserve System, Holding companies.

12 CFR Part 324

    Administrative practice and procedure, Banks, Banking, Capital 
adequacy, Savings associations, State non-member banks.

[[Page 4400]]

12 CFR Part 327

    Bank deposit insurance, Banks, Banking, Savings associations.

Office of the Comptroller of the Currency

    For the reasons set out in the joint preamble, the OCC amends 12 
CFR parts 3 and 32 as follows:

PART 3--CAPITAL ADEQUACY STANDARDS

0
1. The authority citation for part 3 continues to read as follows:

    Authority: 12 U.S.C. 93a, 161, 1462, 1462a, 1463, 1464, 1818, 
1828(n), 1828 note, 1831n note, 1835, 3907, 3909, and 5412(b)(2)(B).


0
2. Section 3.2 is amended by:
0
a. Adding the definitions of ``Basis derivative contract,'' ``Client-
facing derivative transaction,'' and ``Commercial end-user'' in 
alphabetical order;
0
b. Revising the definitions of ``Current exposure'' and ``Current 
exposure methodology;''
0
c. Revising paragraph (2) of the definition of ``Financial 
collateral;''
0
d. Adding the definitions of ``Independent collateral,'' ``Minimum 
transfer amount,'' and ``Net independent collateral amount'' in 
alphabetical order;
0
e. Revising the definition of ``Netting set;'' and
0
f. Adding the definitions of ``Speculative grade,'' ``Sub-speculative 
grade,'' ``Variation margin,'' ``Variation margin agreement,'' 
``Variation margin amount,'' ``Variation margin threshold,'' and 
``Volatility derivative contract'' in alphabetical order.
    The additions and revisions read as follows:


Sec.  3.2  Definitions.

* * * * *
    Basis derivative contract means a non-foreign-exchange derivative 
contract (i.e., the contract is denominated in a single currency) in 
which the cash flows of the derivative contract depend on the 
difference between two risk factors that are attributable solely to one 
of the following derivative asset classes: Interest rate, credit, 
equity, or commodity.
* * * * *
    Client-facing derivative transaction means a derivative contract 
that is not a cleared transaction where the national bank or Federal 
savings association is either acting as a financial intermediary and 
enters into an offsetting transaction with a qualifying central 
counterparty (QCCP) or where the national bank or Federal savings 
association provides a guarantee on the performance of a client on a 
transaction between the client and a QCCP.
* * * * *
    Commercial end-user means an entity that:
    (1)(i) Is using derivative contracts to hedge or mitigate 
commercial risk; and
    (ii)(A) Is not an entity described in section 2(h)(7)(C)(i)(I) 
through (VIII) of the Commodity Exchange Act (7 U.S.C. 2(h)(7)(C)(i)(I) 
through (VIII)); or
    (B) Is not a ``financial entity'' for purposes of section 2(h)(7) 
of the Commodity Exchange Act (7 U.S.C. 2(h)) by virtue of section 
2(h)(7)(C)(iii) of the Act (7 U.S.C. 2(h)(7)(C)(iii)); or
    (2)(i) Is using derivative contracts to hedge or mitigate 
commercial risk; and
    (ii) Is not an entity described in section 3C(g)(3)(A)(i) through 
(viii) of the Securities Exchange Act of 1934 (15 U.S.C. 78c-
3(g)(3)(A)(i) through (viii)); or
    (3) Qualifies for the exemption in section 2(h)(7)(A) of the 
Commodity Exchange Act (7 U.S.C. 2(h)(7)(A)) by virtue of section 
2(h)(7)(D) of the Act (7 U.S.C. 2(h)(7)(D)); or
    (4) Qualifies for an exemption in section 3C(g)(1) of the 
Securities Exchange Act of 1934 (15 U.S.C. 78c-3(g)(1)) by virtue of 
section 3C(g)(4) of the Act (15 U.S.C. 78c-3(g)(4)).
* * * * *
    Current exposure means, with respect to a netting set, the larger 
of zero or the fair value of a transaction or portfolio of transactions 
within the netting set that would be lost upon default of the 
counterparty, assuming no recovery on the value of the transactions.
    Current exposure methodology means the method of calculating the 
exposure amount for over-the-counter derivative contracts in Sec.  
3.34(b).
* * * * *
    Financial collateral * * *
    (2) In which the national bank and Federal savings association has 
a perfected, first-priority security interest or, outside of the United 
States, the legal equivalent thereof (with the exception of cash on 
deposit; and notwithstanding the prior security interest of any 
custodial agent or any priority security interest granted to a CCP in 
connection with collateral posted to that CCP).
* * * * *
    Independent collateral means financial collateral, other than 
variation margin, that is subject to a collateral agreement, or in 
which a national bank and Federal savings association has a perfected, 
first-priority security interest or, outside of the United States, the 
legal equivalent thereof (with the exception of cash on deposit; 
notwithstanding the prior security interest of any custodial agent or 
any prior security interest granted to a CCP in connection with 
collateral posted to that CCP), and the amount of which does not change 
directly in response to the value of the derivative contract or 
contracts that the financial collateral secures.
* * * * *
    Minimum transfer amount means the smallest amount of variation 
margin that may be transferred between counterparties to a netting set 
pursuant to the variation margin agreement.
* * * * *
    Net independent collateral amount means the fair value amount of 
the independent collateral, as adjusted by the standard supervisory 
haircuts under Sec.  3.132(b)(2)(ii), as applicable, that a 
counterparty to a netting set has posted to a national bank or Federal 
savings association less the fair value amount of the independent 
collateral, as adjusted by the standard supervisory haircuts under 
Sec.  3.132(b)(2)(ii), as applicable, posted by the national bank or 
Federal savings association to the counterparty, excluding such amounts 
held in a bankruptcy remote manner or posted to a QCCP and held in 
conformance with the operational requirements in Sec.  3.3.
    Netting set means a group of transactions with a single 
counterparty that are subject to a qualifying master netting agreement. 
For derivative contracts, netting set also includes a single derivative 
contract between a national bank or Federal savings association and a 
single counterparty. For purposes of the internal model methodology 
under Sec.  3.132(d), netting set also includes a group of transactions 
with a single counterparty that are subject to a qualifying cross-
product master netting agreement and does not include a transaction:
    (1) That is not subject to such a master netting agreement; or
    (2) Where the national bank or Federal savings association has 
identified specific wrong-way risk.
* * * * *
    Speculative grade means the reference entity has adequate capacity 
to meet financial commitments in the near term, but is vulnerable to 
adverse economic conditions, such that should economic conditions 
deteriorate, the reference entity would present an elevated default 
risk.
* * * * *
    Sub-speculative grade means the reference entity depends on 
favorable economic conditions to meet its financial commitments, such 
that should such economic conditions deteriorate the reference entity 
likely

[[Page 4401]]

would default on its financial commitments.
* * * * *
    Variation margin means financial collateral that is subject to a 
collateral agreement provided by one party to its counterparty to meet 
the performance of the first party's obligations under one or more 
transactions between the parties as a result of a change in value of 
such obligations since the last time such financial collateral was 
provided.
    Variation margin agreement means an agreement to collect or post 
variation margin.
    Variation margin amount means the fair value amount of the 
variation margin, as adjusted by the standard supervisory haircuts 
under Sec.  3.132(b)(2)(ii), as applicable, that a counterparty to a 
netting set has posted to a national bank or Federal savings 
association less the fair value amount of the variation margin, as 
adjusted by the standard supervisory haircuts under Sec.  
3.132(b)(2)(ii), as applicable, posted by the national bank or Federal 
savings association to the counterparty.
    Variation margin threshold means the amount of credit exposure of a 
national bank or Federal savings association to its counterparty that, 
if exceeded, would require the counterparty to post variation margin to 
the national bank or Federal savings association pursuant to the 
variation margin agreement.
    Volatility derivative contract means a derivative contract in which 
the payoff of the derivative contract explicitly depends on a measure 
of the volatility of an underlying risk factor to the derivative 
contract.
* * * * *

0
 3. Section 3.10 is amended by revising paragraphs (c)(4)(ii)(A) 
through (C) to read as follows:


Sec.  3.10  Minimum capital requirements.

* * * * *
    (c) * * *
    (4) * * *
    (ii) * * *
    (A) The balance sheet carrying value of all of the national bank or 
Federal savings association's on-balance sheet assets, plus the value 
of securities sold under a repurchase transaction or a securities 
lending transaction that qualifies for sales treatment under U.S. GAAP, 
less amounts deducted from tier 1 capital under Sec.  3.22(a), (c), and 
(d), and less the value of securities received in security-for-security 
repo-style transactions, where the national bank or Federal savings 
association acts as a securities lender and includes the securities 
received in its on-balance sheet assets but has not sold or re-
hypothecated the securities received, and, for a national bank or 
Federal savings association that uses the standardized approach for 
counterparty credit risk under Sec.  3.132(c) for its standardized 
risk-weighted assets, less the fair value of any derivative contracts;
    (B)(1) For a national bank or Federal savings association that uses 
the current exposure methodology under Sec.  3.34(b) for its 
standardized risk-weighted assets, the potential future credit exposure 
(PFE) for each derivative contract or each single-product netting set 
of derivative contracts (including a cleared transaction except as 
provided in paragraph (c)(4)(ii)(I) of this section and, at the 
discretion of the national bank or Federal savings association, 
excluding a forward agreement treated as a derivative contract that is 
part of a repurchase or reverse repurchase or a securities borrowing or 
lending transaction that qualifies for sales treatment under U.S. 
GAAP), to which the national bank or Federal savings association is a 
counterparty as determined under Sec.  3.34, but without regard to 
Sec.  3.34(b), provided that:
    (i) A national bank or Federal savings association may choose to 
exclude the PFE of all credit derivatives or other similar instruments 
through which it provides credit protection when calculating the PFE 
under Sec.  3.34, but without regard to Sec.  3.34(b), provided that it 
does not adjust the net-to-gross ratio (NGR); and
    (ii) A national bank or Federal savings association that chooses to 
exclude the PFE of credit derivatives or other similar instruments 
through which it provides credit protection pursuant to paragraph 
(c)(4)(ii)(B)(1) of this section must do so consistently over time for 
the calculation of the PFE for all such instruments; or
    (2)(i) For a national bank or Federal savings association that uses 
the standardized approach for counterparty credit risk under section 
Sec.  3.132(c) for its standardized risk-weighted assets, the PFE for 
each netting set to which the national bank or Federal savings 
association is a counterparty (including cleared transactions except as 
provided in paragraph (c)(4)(ii)(I) of this section and, at the 
discretion of the national bank or Federal savings association, 
excluding a forward agreement treated as a derivative contract that is 
part of a repurchase or reverse repurchase or a securities borrowing or 
lending transaction that qualifies for sales treatment under U.S. 
GAAP), as determined under Sec.  3.132(c)(7)(i), in which the term C in 
Sec.  3.132(c)(7)(i) equals zero except as provided in paragraph 
(c)(4)(ii)(B)(2)(ii) of this section, and, for any counterparty that is 
not a commercial end-user, multiplied by 1.4; and
    (ii) For purposes of paragraph (c)(4)(ii)(B)(2)(i) of this section, 
a national bank or Federal savings association may set the value of the 
term C in Sec.  3.132(c)(7)(i) equal to the amount of collateral posted 
by a clearing member client of the national bank or Federal savings 
association, in connection with the client-facing derivative 
transactions within the netting set;
    (C)(1)(i) For a national bank or Federal savings association that 
uses the current exposure methodology under Sec.  3.34(b) for its 
standardized risk-weighted assets, the amount of cash collateral that 
is received from a counterparty to a derivative contract and that has 
offset the mark-to-fair value of the derivative asset, or cash 
collateral that is posted to a counterparty to a derivative contract 
and that has reduced the national bank or Federal savings association's 
on-balance sheet assets, unless such cash collateral is all or part of 
variation margin that satisfies the conditions in paragraphs 
(c)(4)(ii)(C)(3) through (7) of this section; and
    (ii) The variation margin is used to reduce the current credit 
exposure of the derivative contract, calculated as described in Sec.  
3.34(b), and not the PFE; and
    (iii) For the purpose of the calculation of the NGR described in 
Sec.  3.34(b)(2)(ii)(B), variation margin described in paragraph 
(c)(4)(ii)(C)(1)(ii) of this section may not reduce the net current 
credit exposure or the gross current credit exposure; or
    (2)(i) For a national bank or Federal savings association that uses 
the standardized approach for counterparty credit risk under Sec.  
3.132(c) for its standardized risk-weighted assets, the replacement 
cost of each derivative contract or single product netting set of 
derivative contracts to which the national bank or Federal savings 
association is a counterparty, calculated according to the following 
formula, and, for any counterparty that is not a commercial end-user, 
multiplied by 1.4:

Replacement Cost = max{V-CVMr + CVMp;0{time} 

Where:

V equals the fair value for each derivative contract or each single-
product netting set of derivative contracts (including a cleared 
transaction except as provided in paragraph (c)(4)(ii)(I) of this 
section and, at the discretion of the national bank or Federal 
savings association, excluding a forward agreement treated as a 
derivative contract that is part of a repurchase or

[[Page 4402]]

reverse repurchase or a securities borrowing or lending transaction 
that qualifies for sales treatment under U.S. GAAP);
CVMr equals the amount of cash collateral received from a 
counterparty to a derivative contract and that satisfies the 
conditions in paragraphs (c)(4)(ii)(C)(3) through (7) of this 
section, or, in the case of a client-facing derivative transaction, 
the amount of collateral received from the clearing member client; 
and
CVMp equals the amount of cash collateral that is posted to a 
counterparty to a derivative contract and that has not offset the 
fair value of the derivative contract and that satisfies the 
conditions in paragraphs (c)(4)(ii)(C)(3) through (7) of this 
section, or, in the case of a client-facing derivative transaction, 
the amount of collateral posted to the clearing member client;

    (ii) Notwithstanding paragraph (c)(4)(ii)(C)(2)(i) of this section, 
where multiple netting sets are subject to a single variation margin 
agreement, a national bank or Federal savings association must apply 
the formula for replacement cost provided in Sec.  3.132(c)(10)(i), in 
which the term CMA may only include cash collateral that 
satisfies the conditions in paragraphs (c)(4)(ii)(C)(3) through (7) of 
this section; and
    (iii) For purposes of paragraph (c)(4)(ii)(C)(2)(i), a national 
bank or Federal savings association must treat a derivative contract 
that references an index as if it were multiple derivative contracts 
each referencing one component of the index if the national bank or 
Federal savings association elected to treat the derivative contract as 
multiple derivative contracts under Sec.  3.132(c)(5)(vi);
    (3) For derivative contracts that are not cleared through a QCCP, 
the cash collateral received by the recipient counterparty is not 
segregated (by law, regulation, or an agreement with the counterparty);
    (4) Variation margin is calculated and transferred on a daily basis 
based on the mark-to-fair value of the derivative contract;
    (5) The variation margin transferred under the derivative contract 
or the governing rules of the CCP or QCCP for a cleared transaction is 
the full amount that is necessary to fully extinguish the net current 
credit exposure to the counterparty of the derivative contracts, 
subject to the threshold and minimum transfer amounts applicable to the 
counterparty under the terms of the derivative contract or the 
governing rules for a cleared transaction;
    (6) The variation margin is in the form of cash in the same 
currency as the currency of settlement set forth in the derivative 
contract, provided that for the purposes of this paragraph 
(c)(4)(ii)(C)(6), currency of settlement means any currency for 
settlement specified in the governing qualifying master netting 
agreement and the credit support annex to the qualifying master netting 
agreement, or in the governing rules for a cleared transaction; and
    (7) The derivative contract and the variation margin are governed 
by a qualifying master netting agreement between the legal entities 
that are the counterparties to the derivative contract or by the 
governing rules for a cleared transaction, and the qualifying master 
netting agreement or the governing rules for a cleared transaction must 
explicitly stipulate that the counterparties agree to settle any 
payment obligations on a net basis, taking into account any variation 
margin received or provided under the contract if a credit event 
involving either counterparty occurs;
* * * * *

0
 4. Section 3.32 is amended by revising paragraph (f) to read as 
follows:


Sec.  3.32  General risk weights.

* * * * *
    (f) Corporate exposures. (1) A national bank or Federal savings 
association must assign a 100 percent risk weight to all its corporate 
exposures, except as provided in paragraph (f)(2) of this section.
    (2) A national bank or Federal savings association must assign a 2 
percent risk weight to an exposure to a QCCP arising from the national 
bank or Federal savings association posting cash collateral to the QCCP 
in connection with a cleared transaction that meets the requirements of 
Sec.  3.35(b)(3)(i)(A) and a 4 percent risk weight to an exposure to a 
QCCP arising from the national bank or Federal savings association 
posting cash collateral to the QCCP in connection with a cleared 
transaction that meets the requirements of Sec.  3.35(b)(3)(i)(B).
    (3) A national bank or Federal savings association must assign a 2 
percent risk weight to an exposure to a QCCP arising from the national 
bank or Federal savings association posting cash collateral to the QCCP 
in connection with a cleared transaction that meets the requirements of 
Sec.  3.35(c)(3)(i).
* * * * *

0
5. Section 3.34 is revised to read as follows:


Sec.  3.34   Derivative contracts.

    (a) Exposure amount for derivative contracts--(1) National bank or 
Federal savings association that is not an advanced approaches national 
bank or Federal savings association. (i) A national bank or Federal 
savings association that is not an advanced approaches national bank or 
Federal savings association must use the current exposure methodology 
(CEM) described in paragraph (b) of this section to calculate the 
exposure amount for all its OTC derivative contracts, unless the 
national bank or Federal savings association makes the election 
provided in paragraph (a)(1)(ii) of this section.
    (ii) A national bank or Federal savings association that is not an 
advanced approaches national bank or Federal savings association may 
elect to calculate the exposure amount for all its OTC derivative 
contracts under the standardized approach for counterparty credit risk 
(SA-CCR) in Sec.  3.132(c) by notifying the OCC, rather than 
calculating the exposure amount for all its derivative contracts using 
CEM. A national bank or Federal savings association that elects under 
this paragraph (a)(1)(ii) to calculate the exposure amount for its OTC 
derivative contracts under SA-CCR must apply the treatment of cleared 
transactions under Sec.  3.133 to its derivative contracts that are 
cleared transactions and to all default fund contributions associated 
with such derivative contracts, rather than applying Sec.  3.35. A 
national bank or Federal savings association that is not an advanced 
approaches national bank or Federal savings association must use the 
same methodology to calculate the exposure amount for all its 
derivative contracts and, if a national bank or Federal savings 
association has elected to use SA-CCR under this paragraph (a)(1)(ii), 
the national bank or Federal savings association may change its 
election only with prior approval of the OCC.
    (2) Advanced approaches national bank or Federal savings 
association. An advanced approaches national bank or Federal savings 
association must calculate the exposure amount for all its derivative 
contracts using SA-CCR in Sec.  3.132(c) for purposes of standardized 
total risk-weighted assets. An advanced approaches national bank or 
Federal savings association must apply the treatment of cleared 
transactions under Sec.  3.133 to its derivative contracts that are 
cleared transactions and to all default fund contributions associated 
with such derivative contracts for purposes of standardized total risk-
weighted assets.
    (b) Current exposure methodology exposure amount--(1) Single OTC 
derivative contract. Except as modified by paragraph (c) of this 
section, the exposure amount for a single OTC derivative contract that 
is not subject to

[[Page 4403]]

a qualifying master netting agreement is equal to the sum of the 
national bank's or Federal savings association's current credit 
exposure and potential future credit exposure (PFE) on the OTC 
derivative contract.
    (i) Current credit exposure. The current credit exposure for a 
single OTC derivative contract is the greater of the fair value of the 
OTC derivative contract or zero.
    (ii) PFE. (A) The PFE for a single OTC derivative contract, 
including an OTC derivative contract with a negative fair value, is 
calculated by multiplying the notional principal amount of the OTC 
derivative contract by the appropriate conversion factor in Table 1 to 
this section.
    (B) For purposes of calculating either the PFE under this paragraph 
(b)(1)(ii) or the gross PFE under paragraph (b)(2)(ii)(A) of this 
section for exchange rate contracts and other similar contracts in 
which the notional principal amount is equivalent to the cash flows, 
notional principal amount is the net receipts to each party falling due 
on each value date in each currency.
    (C) For an OTC derivative contract that does not fall within one of 
the specified categories in Table 1 to this section, the PFE must be 
calculated using the appropriate ``other'' conversion factor.
    (D) A national bank or Federal savings association must use an OTC 
derivative contract's effective notional principal amount (that is, the 
apparent or stated notional principal amount multiplied by any 
multiplier in the OTC derivative contract) rather than the apparent or 
stated notional principal amount in calculating PFE.
    (E) The PFE of the protection provider of a credit derivative is 
capped at the net present value of the amount of unpaid premiums.

                                      Table 1 to Sec.   3.34--Conversion Factor Matrix for Derivative Contracts \1\
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                              Credit       Credit (non-
                                                              Foreign       (investment     investment-                      Precious
         Remaining maturity \2\            Interest rate   exchange rate       grade           grade          Equity      metals (except       Other
                                                             and gold        reference       reference                         gold)
                                                                            asset) \3\        asset)
--------------------------------------------------------------------------------------------------------------------------------------------------------
One year or less........................            0.00            0.01            0.05            0.10            0.06            0.07            0.10
Greater than one year and less than or             0.005            0.05            0.05            0.10            0.08            0.07            0.12
 equal to five years....................
Greater than five years.................           0.015           0.075            0.05            0.10            0.10            0.08            0.15
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ For a derivative contract with multiple exchanges of principal, the conversion factor is multiplied by the number of remaining payments in the
  derivative contract.
\2\ For an OTC derivative contract that is structured such that on specified dates any outstanding exposure is settled and the terms are reset so that
  the fair value of the contract is zero, the remaining maturity equals the time until the next reset date. For an interest rate derivative contract
  with a remaining maturity of greater than one year that meets these criteria, the minimum conversion factor is 0.005.
\3\ A national bank or Federal savings association must use the column labeled ``Credit (investment-grade reference asset)'' for a credit derivative
  whose reference asset is an outstanding unsecured long-term debt security without credit enhancement that is investment grade. A national bank or
  Federal savings association must use the column labeled ``Credit (non-investment-grade reference asset)'' for all other credit derivatives.

    (2) Multiple OTC derivative contracts subject to a qualifying 
master netting agreement. Except as modified by paragraph (c) of this 
section, the exposure amount for multiple OTC derivative contracts 
subject to a qualifying master netting agreement is equal to the sum of 
the net current credit exposure and the adjusted sum of the PFE amounts 
for all OTC derivative contracts subject to the qualifying master 
netting agreement.
    (i) Net current credit exposure. The net current credit exposure is 
the greater of the net sum of all positive and negative fair values of 
the individual OTC derivative contracts subject to the qualifying 
master netting agreement or zero.
    (ii) Adjusted sum of the PFE amounts. The adjusted sum of the PFE 
amounts, Anet, is calculated as Anet = (0.4 x Agross) + (0.6 x NGR x 
Agross), where:
    (A) Agross = the gross PFE (that is, the sum of the PFE amounts as 
determined under paragraph (b)(1)(ii) of this section for each 
individual derivative contract subject to the qualifying master netting 
agreement); and
    (B) Net-to-gross Ratio (NGR) = the ratio of the net current credit 
exposure to the gross current credit exposure. In calculating the NGR, 
the gross current credit exposure equals the sum of the positive 
current credit exposures (as determined under paragraph (b)(1)(i) of 
this section) of all individual derivative contracts subject to the 
qualifying master netting agreement.
    (c) Recognition of credit risk mitigation of collateralized OTC 
derivative contracts. (1) A national bank or Federal savings 
association using CEM under paragraph (b) of this section may recognize 
the credit risk mitigation benefits of financial collateral that 
secures an OTC derivative contract or multiple OTC derivative contracts 
subject to a qualifying master netting agreement (netting set) by using 
the simple approach in Sec.  3.37(b).
    (2) As an alternative to the simple approach, a national bank or 
Federal savings association using CEM under paragraph (b) of this 
section may recognize the credit risk mitigation benefits of financial 
collateral that secures such a contract or netting set if the financial 
collateral is marked-to-fair value on a daily basis and subject to a 
daily margin maintenance requirement by applying a risk weight to the 
uncollateralized portion of the exposure, after adjusting the exposure 
amount calculated under paragraph (b)(1) or (2) of this section using 
the collateral haircut approach in Sec.  3.37(c). The national bank or 
Federal savings association must substitute the exposure amount 
calculated under paragraph (b)(1) or (2) of this section for [Sigma]E 
in the equation in Sec.  3.37(c)(2).
    (d) Counterparty credit risk for credit derivatives--(1) Protection 
purchasers. A national bank or Federal savings association that 
purchases a credit derivative that is recognized under Sec.  3.36 as a 
credit risk mitigant for an exposure that is not a covered position 
under subpart F of this part is not required to compute a separate 
counterparty credit risk capital requirement under this subpart 
provided that the national bank or Federal savings association does so 
consistently for all such credit derivatives. The national bank or 
Federal savings association must either include all or exclude all such 
credit derivatives that are subject to a qualifying master netting 
agreement from any measure used to determine counterparty credit risk 
exposure to all relevant counterparties for risk-based capital 
purposes.
    (2) Protection providers. (i) A national bank or Federal savings 
association that is the protection provider under a credit derivative 
must treat the credit derivative as an exposure to the underlying 
reference asset. The national bank or Federal savings association is

[[Page 4404]]

not required to compute a counterparty credit risk capital requirement 
for the credit derivative under this subpart, provided that this 
treatment is applied consistently for all such credit derivatives. The 
national bank or Federal savings association must either include all or 
exclude all such credit derivatives that are subject to a qualifying 
master netting agreement from any measure used to determine 
counterparty credit risk exposure.
    (ii) The provisions of this paragraph (d)(2) apply to all relevant 
counterparties for risk-based capital purposes unless the national bank 
or Federal savings association is treating the credit derivative as a 
covered position under subpart F of this part, in which case the 
national bank or Federal savings association must compute a 
supplemental counterparty credit risk capital requirement under this 
section.
    (e) Counterparty credit risk for equity derivatives. (1) A national 
bank or Federal savings association must treat an equity derivative 
contract as an equity exposure and compute a risk-weighted asset amount 
for the equity derivative contract under Sec. Sec.  3.51 through 3.53 
(unless the national bank or Federal savings association is treating 
the contract as a covered position under subpart F of this part).
    (2) In addition, the national bank or Federal savings association 
must also calculate a risk-based capital requirement for the 
counterparty credit risk of an equity derivative contract under this 
section if the national bank or Federal savings association is treating 
the contract as a covered position under subpart F of this part.
    (3) If the national bank or Federal savings association risk 
weights the contract under the Simple Risk-Weight Approach (SRWA) in 
Sec.  3.52, the national bank or Federal savings association may choose 
not to hold risk-based capital against the counterparty credit risk of 
the equity derivative contract, as long as it does so for all such 
contracts. Where the equity derivative contracts are subject to a 
qualified master netting agreement, a national bank or Federal savings 
association using the SRWA must either include all or exclude all of 
the contracts from any measure used to determine counterparty credit 
risk exposure.
    (f) Clearing member national bank's or Federal savings 
association's exposure amount. The exposure amount of a clearing member 
national bank or Federal savings association using CEM under paragraph 
(b) of this section for a client-facing derivative transaction or 
netting set of client-facing derivative transactions equals the 
exposure amount calculated according to paragraph (b)(1) or (2) of this 
section multiplied by the scaling factor of the square root of \1/2\ 
(which equals 0.707107). If the national bank or Federal savings 
association determines that a longer period is appropriate, the 
national bank or Federal savings association must use a larger scaling 
factor to adjust for a longer holding period as follows:
[GRAPHIC] [TIFF OMITTED] TR24JA20.012

Where H = the holding period greater than or equal to five days.

    Additionally, the OCC may require the national bank or Federal 
savings association to set a longer holding period if the OCC 
determines that a longer period is appropriate due to the nature, 
structure, or characteristics of the transaction or is commensurate 
with the risks associated with the transaction.

0
6. Section 3.35 is amended by adding paragraph (a)(3), revising 
paragraph (b)(4)(i), and adding paragraph (c)(3)(iii) to read as 
follows:


Sec.  3.35  Cleared transactions.

    (a) * * *
    (3) Alternate requirements. Notwithstanding any other provision of 
this section, an advanced approaches national bank or Federal savings 
association or a national bank or Federal savings association that is 
not an advanced approaches national bank or Federal savings association 
and that has elected to use SA-CCR under Sec.  3.34(a)(1) must apply 
Sec.  3.133 to its derivative contracts that are cleared transactions 
rather than this section.
    (b) * * *
    (4) * * *
    (i) Notwithstanding any other requirements in this section, 
collateral posted by a clearing member client national bank or Federal 
savings association that is held by a custodian (in its capacity as 
custodian) in a manner that is bankruptcy remote from the CCP, clearing 
member, and other clearing member clients of the clearing member, is 
not subject to a capital requirement under this section.
* * * * *
    (c) * * *
    (3) * * *
    (iii) Notwithstanding paragraphs (c)(3)(i) and (ii) of this 
section, a clearing member national bank or Federal savings association 
may apply a risk weight of zero percent to the trade exposure amount 
for a cleared transaction with a CCP where the clearing member national 
bank or Federal savings association is acting as a financial 
intermediary on behalf of a clearing member client, the transaction 
offsets another transaction that satisfies the requirements set forth 
in Sec.  3.3(a), and the clearing member national bank or Federal 
savings association is not obligated to reimburse the clearing member 
client in the event of the CCP default.
* * * * *

0
 7. Section 3.37 is amended by revising paragraphs (c)(3)(iii), 
(c)(3)(iv)(A) and (C), (c)(4)(i)(B) introductory text, and 
(c)(4)(i)(B)(1) to read as follows:


Sec.  3.37   Collateralized transactions.

* * * * *
    (c) * * *
    (3) * * *
    (iii) For repo-style transactions and client-facing derivative 
transactions, a national bank or Federal savings association may 
multiply the standard supervisory haircuts provided in paragraphs 
(c)(3)(i) and (ii) of this section by the square root of \1/2\ (which 
equals 0.707107). For client-facing derivative transactions, if a 
larger scaling factor is applied under Sec.  3.34(f), the same factor 
must be used to adjust the supervisory haircuts.
    (iv) * * *
    (A) TM equals a holding period of longer than 10 
business days for eligible margin loans and derivative contracts other 
than client-facing derivative transactions or longer than 5 business 
days for repo-style transactions and client-facing derivative 
transactions;
* * * * *
    (C) TS equals 10 business days for eligible margin loans 
and derivative contracts other than client-facing derivative 
transactions or 5 business days for repo-style transactions and client-
facing derivative transactions.
* * * * *
    (4) * * *
    (i) * * *
    (B) The minimum holding period for a repo-style transaction and 
client-facing derivative transaction is five business days and for an 
eligible margin loan and a derivative contract other than a client-
facing derivative transaction is ten business days except for 
transactions or netting sets for which paragraph (c)(4)(i)(C) of this 
section applies. When a national bank or Federal savings association 
calculates an own-estimates haircut on a TN-day holding 
period, which is different from the minimum holding period for the 
transaction type, the applicable haircut

[[Page 4405]]

(HM) is calculated using the following square root of time 
formula:
* * * * *
    (1) TM equals 5 for repo-style transactions and client-
facing derivative transactions and 10 for eligible margin loans and 
derivative contracts other than client-facing derivative transactions;
* * * * *


Sec.  Sec.  3.134, 3.202, and 3.210  [Amended]

0
 8. For each section listed in the following table, the footnote number 
listed in the ``Old footnote number'' column is redesignated as the 
footnote number listed in the ``New footnote number'' column as 
follows:

------------------------------------------------------------------------
                                           Old footnote    New footnote
                 Section                      number          number
------------------------------------------------------------------------
3.134(d)(3).............................              30              31
3.202, paragraph (1) introductory text                31              32
 of the definition of ``Covered
 position''.............................
3.202, paragraph (1)(i) of the                        32              33
 definition of ``Covered position''.....
3.210(e)(1).............................              33              34
------------------------------------------------------------------------


0
9. Section 3.132 is amended by:
0
a. Revising paragraphs (b)(2)(ii)(A)(3) through (5);
0
b. Adding paragraphs (b)(2)(ii)(A)(6) and (7);
0
c. Revising paragraphs (c) heading and (c)(1) and (2) and (5) through 
(8);
0
d. Adding paragraphs (c)(9) through (11);
0
e. Revising paragraph (d)(10)(i);
0
f. In paragraphs (e)(5)(i)(A) and (H), removing ``Table 3 to Sec.  
3.132'' and adding in its place ``Table 4 to this section'';
0
g. In paragraphs (e)(5)(i)(C) and (e)(6)(i)(B), removing ``current 
exposure methodology'' and adding in its place ``standardized approach 
for counterparty credit risk methodology'' wherever it appears;
0
h. Redesignating Table 3 to Sec.  3.132 following paragraph (e)(5)(ii) 
as Table 4 to Sec.  3.132; and
0
i. Revising paragraph (e)(6)(viii).
    The revisions and additions read as follows:


Sec.  3.132   Counterparty credit risk of repo-style transactions, 
eligible margin loans, and OTC derivative contracts.

* * * * *
    (b) * * *
    (2) * * *
    (ii) * * *
    (A) * * *
    (3) For repo-style transactions and client-facing derivative 
transactions, a national bank or Federal savings association may 
multiply the supervisory haircuts provided in paragraphs 
(b)(2)(ii)(A)(1) and (2) of this section by the square root of \1/2\ 
(which equals 0.707107). If the national bank or Federal savings 
association determines that a longer holding period is appropriate for 
client-facing derivative transactions, then it must use a larger 
scaling factor to adjust for the longer holding period pursuant to 
paragraph (b)(2)(ii)(A)(6) of this section.
    (4) A national bank or Federal savings association must adjust the 
supervisory haircuts upward on the basis of a holding period longer 
than ten business days (for eligible margin loans) or five business 
days (for repo-style transactions), using the formula provided in 
paragraph (b)(2)(ii)(A)(6) of this section where the conditions in this 
paragraph (b)(2)(ii)(A)(4) apply. If the number of trades in a netting 
set exceeds 5,000 at any time during a quarter, a national bank or 
Federal savings association must adjust the supervisory haircuts upward 
on the basis of a minimum holding period of twenty business days for 
the following quarter (except when a national bank or Federal savings 
association is calculating EAD for a cleared transaction under Sec.  
3.133). If a netting set contains one or more trades involving illiquid 
collateral, a national bank or Federal savings association must adjust 
the supervisory haircuts upward on the basis of a minimum holding 
period of twenty business days. If over the two previous quarters more 
than two margin disputes on a netting set have occurred that lasted 
longer than the holding period, then the national bank or Federal 
savings association must adjust the supervisory haircuts upward for 
that netting set on the basis of a minimum holding period that is at 
least two times the minimum holding period for that netting set.
    (5)(i) A national bank or Federal savings association must adjust 
the supervisory haircuts upward on the basis of a holding period longer 
than ten business days for collateral associated with derivative 
contracts (five business days for client-facing derivative contracts) 
using the formula provided in paragraph (b)(2)(ii)(A)(6) of this 
section where the conditions in this paragraph (b)(2)(ii)(A)(5)(i) 
apply. For collateral associated with a derivative contract that is 
within a netting set that is composed of more than 5,000 derivative 
contracts that are not cleared transactions, a national bank or Federal 
savings association must use a minimum holding period of twenty 
business days. If a netting set contains one or more trades involving 
illiquid collateral or a derivative contract that cannot be easily 
replaced, a national bank or Federal savings association must use a 
minimum holding period of twenty business days.
    (ii) Notwithstanding paragraph (b)(2)(ii)(A)(1) or (3) or 
(b)(2)(ii)(A)(5)(i) of this section, for collateral associated with a 
derivative contract in a netting set under which more than two margin 
disputes that lasted longer than the holding period occurred during the 
previous two quarters, the minimum holding period is twice the amount 
provided under paragraph (b)(2)(ii)(A)(1) or (3) or (b)(2)(ii)(A)(5)(i) 
of this section.
    (6) A national bank or Federal savings association must adjust the 
standard supervisory haircuts upward, pursuant to the adjustments 
provided in paragraphs (b)(2)(ii)(A)(3) through (5) of this section, 
using the following formula:
[GRAPHIC] [TIFF OMITTED] TR24JA20.013

Where:

TM equals a holding period of longer than 10 business 
days for eligible margin loans and derivative contracts other than 
client-facing derivative transactions or longer than 5 business days 
for repo-style transactions and client-facing derivative 
transactions;
HS equals the standard supervisory haircut; and
TS equals 10 business days for eligible margin loans and 
derivative contracts other than client-facing derivative 
transactions or 5 business days for repo-style transactions and 
client-facing derivative transactions.

    (7) If the instrument a national bank or Federal savings 
association has lent, sold subject to repurchase, or posted as 
collateral does not meet the definition of

[[Page 4406]]

financial collateral, the national bank or Federal savings association 
must use a 25.0 percent haircut for market price volatility 
(HS).
* * * * *
    (c) EAD for derivative contracts--(1) Options for determining EAD. 
A national bank or Federal savings association must determine the EAD 
for a derivative contract using the standardized approach for 
counterparty credit risk (SA-CCR) under paragraph (c)(5) of this 
section or using the internal models methodology described in paragraph 
(d) of this section. If a national bank or Federal savings association 
elects to use SA-CCR for one or more derivative contracts, the exposure 
amount determined under SA-CCR is the EAD for the derivative contract 
or derivative contracts. A national bank or Federal savings association 
must use the same methodology to calculate the exposure amount for all 
its derivative contracts and may change its election only with prior 
approval of the OCC. A national bank or Federal savings association may 
reduce the EAD calculated according to paragraph (c)(5) of this section 
by the credit valuation adjustment that the national bank or Federal 
savings association has recognized in its balance sheet valuation of 
any derivative contracts in the netting set. For purposes of this 
paragraph (c)(1), the credit valuation adjustment does not include any 
adjustments to common equity tier 1 capital attributable to changes in 
the fair value of the national bank's or Federal savings association's 
liabilities that are due to changes in its own credit risk since the 
inception of the transaction with the counterparty.
    (2) Definitions. For purposes of this paragraph (c) of this 
section, the following definitions apply:
    (i) End date means the last date of the period referenced by an 
interest rate or credit derivative contract or, if the derivative 
contract references another instrument, by the underlying instrument, 
except as otherwise provided in paragraph (c) of this section.
    (ii) Start date means the first date of the period referenced by an 
interest rate or credit derivative contract or, if the derivative 
contract references the value of another instrument, by underlying 
instrument, except as otherwise provided in paragraph (c) of this 
section.
    (iii) Hedging set means:
    (A) With respect to interest rate derivative contracts, all such 
contracts within a netting set that reference the same reference 
currency;
    (B) With respect to exchange rate derivative contracts, all such 
contracts within a netting set that reference the same currency pair;
    (C) With respect to credit derivative contract, all such contracts 
within a netting set;
    (D) With respect to equity derivative contracts, all such contracts 
within a netting set;
    (E) With respect to a commodity derivative contract, all such 
contracts within a netting set that reference one of the following 
commodity categories: Energy, metal, agricultural, or other 
commodities;
    (F) With respect to basis derivative contracts, all such contracts 
within a netting set that reference the same pair of risk factors and 
are denominated in the same currency; or
    (G) With respect to volatility derivative contracts, all such 
contracts within a netting set that reference one of interest rate, 
exchange rate, credit, equity, or commodity risk factors, separated 
according to the requirements under paragraphs (c)(2)(iii)(A) through 
(E) of this section.
    (H) If the risk of a derivative contract materially depends on more 
than one of interest rate, exchange rate, credit, equity, or commodity 
risk factors, the OCC may require a national bank or Federal savings 
association to include the derivative contract in each appropriate 
hedging set under paragraphs (c)(2)(iii)(A) through (E) of this 
section.
* * * * *
    (5) Exposure amount. (i) The exposure amount of a netting set, as 
calculated under paragraph (c) of this section, is equal to 1.4 
multiplied by the sum of the replacement cost of the netting set, as 
calculated under paragraph (c)(6) of this section, and the potential 
future exposure of the netting set, as calculated under paragraph 
(c)(7) of this section.
    (ii) Notwithstanding the requirements of paragraph (c)(5)(i) of 
this section, the exposure amount of a netting set subject to a 
variation margin agreement, excluding a netting set that is subject to 
a variation margin agreement under which the counterparty to the 
variation margin agreement is not required to post variation margin, is 
equal to the lesser of the exposure amount of the netting set 
calculated under paragraph (c)(5)(i) of this section and the exposure 
amount of the netting set calculated as if the netting set were not 
subject to a variation margin agreement.
    (iii) Notwithstanding the requirements of paragraph (c)(5)(i) of 
this section, the exposure amount of a netting set that consists of 
only sold options in which the premiums have been fully paid by the 
counterparty to the options and where the options are not subject to a 
variation margin agreement is zero.
    (iv) Notwithstanding the requirements of paragraph (c)(5)(i) of 
this section, the exposure amount of a netting set in which the 
counterparty is a commercial end-user is equal to the sum of 
replacement cost, as calculated under paragraph (c)(6) of this section, 
and the potential future exposure of the netting set, as calculated 
under paragraph (c)(7) of this section.
    (v) For purposes of the exposure amount calculated under paragraph 
(c)(5)(i) of this section and all calculations that are part of that 
exposure amount, a national bank or Federal savings association may 
elect, at the netting set level, to treat a derivative contract that is 
a cleared transaction that is not subject to a variation margin 
agreement as one that is subject to a variation margin agreement, if 
the derivative contract is subject to a requirement that the 
counterparties make daily cash payments to each other to account for 
changes in the fair value of the derivative contract and to reduce the 
net position of the contract to zero. If a national bank or Federal 
savings association makes an election under this paragraph (c)(5)(v) 
for one derivative contract, it must treat all other derivative 
contracts within the same netting set that are eligible for an election 
under this paragraph (c)(5)(v) as derivative contracts that are subject 
to a variation margin agreement.
    (vi) For purposes of the exposure amount calculated under paragraph 
(c)(5)(i) of this section and all calculations that are part of that 
exposure amount, a national bank or Federal savings association may 
elect to treat a credit derivative contract, equity derivative 
contract, or commodity derivative contract that references an index as 
if it were multiple derivative contracts each referencing one component 
of the index.
    (6) Replacement cost of a netting set--(i) Netting set subject to a 
variation margin agreement under which the counterparty must post 
variation margin. The replacement cost of a netting set subject to a 
variation margin agreement, excluding a netting set that is subject to 
a variation margin agreement under which the counterparty is not 
required to post variation margin, is the greater of:
    (A) The sum of the fair values (after excluding any valuation 
adjustments) of the derivative contracts within the netting set less 
the sum of the net independent collateral amount and the

[[Page 4407]]

variation margin amount applicable to such derivative contracts;
    (B) The sum of the variation margin threshold and the minimum 
transfer amount applicable to the derivative contracts within the 
netting set less the net independent collateral amount applicable to 
such derivative contracts; or
    (C) Zero.
    (ii) Netting sets not subject to a variation margin agreement under 
which the counterparty must post variation margin. The replacement cost 
of a netting set that is not subject to a variation margin agreement 
under which the counterparty must post variation margin to the national 
bank or Federal savings association is the greater of:
    (A) The sum of the fair values (after excluding any valuation 
adjustments) of the derivative contracts within the netting set less 
the sum of the net independent collateral amount and variation margin 
amount applicable to such derivative contracts; or
    (B) Zero.
    (iii) Multiple netting sets subject to a single variation margin 
agreement. Notwithstanding paragraphs (c)(6)(i) and (ii) of this 
section, the replacement cost for multiple netting sets subject to a 
single variation margin agreement must be calculated according to 
paragraph (c)(10)(i) of this section.
    (iv) Netting set subject to multiple variation margin agreements or 
a hybrid netting set. Notwithstanding paragraphs (c)(6)(i) and (ii) of 
this section, the replacement cost for a netting set subject to 
multiple variation margin agreements or a hybrid netting set must be 
calculated according to paragraph (c)(11)(i) of this section.
    (7) Potential future exposure of a netting set. The potential 
future exposure of a netting set is the product of the PFE multiplier 
and the aggregated amount.
    (i) PFE multiplier. The PFE multiplier is calculated according to 
the following formula:
[GRAPHIC] [TIFF OMITTED] TR24JA20.014

Where:

V is the sum of the fair values (after excluding any valuation 
adjustments) of the derivative contracts within the netting set;
C is the sum of the net independent collateral amount and the 
variation margin amount applicable to the derivative contracts 
within the netting set; and
A is the aggregated amount of the netting set.

    (ii) Aggregated amount. The aggregated amount is the sum of all 
hedging set amounts, as calculated under paragraph (c)(8) of this 
section, within a netting set.
    (iii) Multiple netting sets subject to a single variation margin 
agreement. Notwithstanding paragraphs (c)(7)(i) and (ii) of this 
section and when calculating the potential future exposure for purposes 
of total leverage exposure under Sec.  3.10(c)(4)(ii)(B), the potential 
future exposure for multiple netting sets subject to a single variation 
margin agreement must be calculated according to paragraph (c)(10)(ii) 
of this section.
    (iv) Netting set subject to multiple variation margin agreements or 
a hybrid netting set. Notwithstanding paragraphs (c)(7)(i) and (ii) of 
this section and when calculating the potential future exposure for 
purposes of total leverage exposure under Sec.  3.10(c)(4)(ii)(B), the 
potential future exposure for a netting set subject to multiple 
variation margin agreements or a hybrid netting set must be calculated 
according to paragraph (c)(11)(ii) of this section.
    (8) Hedging set amount--(i) Interest rate derivative contracts. To 
calculate the hedging set amount of an interest rate derivative 
contract hedging set, a national bank or Federal savings association 
may use either of the formulas provided in paragraphs (c)(8)(i)(A) and 
(B) of this section:
    (A) Formula 1 is as follows:
    [GRAPHIC] [TIFF OMITTED] TR24JA20.015
    
    (B) Formula 2 is as follows:

Hedging set amount = [bond]AddOnTB1IR[bond] + 
[bond]AddOnTB2IR[bond] + [bond]AddOnTB3IR[bond].

Where in paragraphs (c)(8)(i)(A) and (B) of this section:

AddOnTB1IR is the sum of the adjusted derivative contract 
amounts, as calculated under paragraph (c)(9) of this section, 
within the hedging set with an end date of less than one year from 
the present date;
AddOnTB2IR is the sum of the adjusted derivative contract 
amounts, as calculated under paragraph (c)(9) of this section, 
within the hedging set with an end date of one to five years from 
the present date; and
AddOnTB3IR is the sum of the adjusted derivative contract 
amounts, as calculated under paragraph (c)(9) of this section, 
within the hedging set with an end date of more than five years from 
the present date.

    (ii) Exchange rate derivative contracts. For an exchange rate 
derivative contract hedging set, the hedging set amount equals the 
absolute value of the sum of the adjusted derivative contract amounts, 
as calculated under paragraph (c)(9) of this section, within the 
hedging set.
    (iii) Credit derivative contracts and equity derivative contracts. 
The hedging set amount of a credit derivative contract hedging set or 
equity derivative contract hedging set within a netting set is 
calculated according to the following formula:

[[Page 4408]]

[GRAPHIC] [TIFF OMITTED] TR24JA20.016

Where:

k is each reference entity within the hedging set.
K is the number of reference entities within the hedging set.
AddOn(Refk) equals the sum of the adjusted derivative contract 
amounts, as determined under paragraph (c)(9) of this section, for 
all derivative contracts within the hedging set that reference 
reference entity k.
[rho]k equals the applicable supervisory correlation factor, as 
provided in Table 2 to this section.

    (iv) Commodity derivative contracts. The hedging set amount of a 
commodity derivative contract hedging set within a netting set is 
calculated according to the following formula:
[GRAPHIC] [TIFF OMITTED] TR24JA20.017

Where:

k is each commodity type within the hedging set.
K is the number of commodity types within the hedging set.
AddOn(Typek) equals the sum of the adjusted derivative contract 
amounts, as determined under paragraph (c)(9) of this section, for 
all derivative contracts within the hedging set that reference 
reference commodity type k.
[rho] equals the applicable supervisory correlation factor, as 
provided in Table 2 to this section.

    (v) Basis derivative contracts and volatility derivative contracts. 
Notwithstanding paragraphs (c)(8)(i) through (iv) of this section, a 
national bank or Federal savings association must calculate a separate 
hedging set amount for each basis derivative contract hedging set and 
each volatility derivative contract hedging set. A national bank or 
Federal savings association must calculate such hedging set amounts 
using one of the formulas under paragraphs (c)(8)(i) through (iv) of 
this section that corresponds to the primary risk factor of the hedging 
set being calculated.
    (9) Adjusted derivative contract amount--(i) Summary. To calculate 
the adjusted derivative contract amount of a derivative contract, a 
national bank or Federal savings association must determine the 
adjusted notional amount of derivative contract, pursuant to paragraph 
(c)(9)(ii) of this section, and multiply the adjusted notional amount 
by each of the supervisory delta adjustment, pursuant to paragraph 
(c)(9)(iii) of this section, the maturity factor, pursuant to paragraph 
(c)(9)(iv) of this section, and the applicable supervisory factor, as 
provided in Table 2 to this section.
    (ii) Adjusted notional amount. (A)(1) For an interest rate 
derivative contract or a credit derivative contract, the adjusted 
notional amount equals the product of the notional amount of the 
derivative contract, as measured in U.S. dollars using the exchange 
rate on the date of the calculation, and the supervisory duration, as 
calculated by the following formula:
[GRAPHIC] [TIFF OMITTED] TR24JA20.018

Where:

S is the number of business days from the present day until the 
start date of the derivative contract, or zero if the start date has 
already passed; and
E is the number of business days from the present day until the end 
date of the derivative contract.

    (2) For purposes of paragraph (c)(9)(ii)(A)(1) of this section:
    (i) For an interest rate derivative contract or credit derivative 
contract that is a variable notional swap, the notional amount is equal 
to the time-weighted average of the contractual notional amounts of 
such a swap over the remaining life of the swap; and
    (ii) For an interest rate derivative contract or a credit 
derivative contract that is a leveraged swap, in which the notional 
amount of all legs of the derivative contract are divided by a factor 
and all rates of the derivative contract are multiplied by the same 
factor, the notional amount is equal to the notional amount of an 
equivalent unleveraged swap.
    (B)(1) For an exchange rate derivative contract, the adjusted 
notional amount is the notional amount of the non-U.S. denominated 
currency leg of the derivative contract, as measured in U.S. dollars 
using the exchange rate on the date of the calculation. If both legs of 
the exchange rate derivative contract are denominated in currencies 
other than U.S. dollars, the adjusted notional amount of the derivative 
contract is the largest leg of the derivative contract, as measured in 
U.S. dollars using the exchange rate on the date of the calculation.
    (2) Notwithstanding paragraph (c)(9)(ii)(B)(1) of this section, for 
an exchange rate derivative contract with multiple exchanges of 
principal, the national bank or Federal savings

[[Page 4409]]

association must set the adjusted notional amount of the derivative 
contract equal to the notional amount of the derivative contract 
multiplied by the number of exchanges of principal under the derivative 
contract.
    (C)(1) For an equity derivative contract or a commodity derivative 
contract, the adjusted notional amount is the product of the fair value 
of one unit of the reference instrument underlying the derivative 
contract and the number of such units referenced by the derivative 
contract.
    (2) Notwithstanding paragraph (c)(9)(ii)(C)(1) of this section, 
when calculating the adjusted notional amount for an equity derivative 
contract or a commodity derivative contract that is a volatility 
derivative contract, the national bank or Federal savings association 
must replace the unit price with the underlying volatility referenced 
by the volatility derivative contract and replace the number of units 
with the notional amount of the volatility derivative contract.
    (iii) Supervisory delta adjustments. (A) For a derivative contract 
that is not an option contract or collateralized debt obligation 
tranche, the supervisory delta adjustment is 1 if the fair value of the 
derivative contract increases when the value of the primary risk factor 
increases and -1 if the fair value of the derivative contract decreases 
when the value of the primary risk factor increases.
    (B)(1) For a derivative contract that is an option contract, the 
supervisory delta adjustment is determined by the following formulas, 
as applicable:
[GRAPHIC] [TIFF OMITTED] TR24JA20.019

    (2) As used in the formulas in Table 2 to this section:
    (i) [Phi] is the standard normal cumulative distribution function;
    (ii) P equals the current fair value of the instrument or risk 
factor, as applicable, underlying the option;
    (iii) K equals the strike price of the option;
    (iv) T equals the number of business days until the latest 
contractual exercise date of the option;
    (v) [lgr] equals zero for all derivative contracts except interest 
rate options for the currencies where interest rates have negative 
values. The same value of [lgr] must be used for all interest rate 
options that are denominated in the same currency. To determine the 
value of [lgr] for a given currency, a national bank or Federal savings 
association must find the lowest value L of P and K of all interest 
rate options in a given currency that the national bank or Federal 
savings association has with all counterparties. Then, [lgr] is set 
according to this formula: [lgr] = max{-L + 0.1%, 0{time} ; and
    (vi) [sigma] equals the supervisory option volatility, as provided 
in Table 3 to of this section.
    (C)(1) For a derivative contract that is a collateralized debt 
obligation tranche, the supervisory delta adjustment is determined by 
the following formula:
[GRAPHIC] [TIFF OMITTED] TR24JA20.020

    (2) As used in the formula in paragraph (c)(9)(iii)(C)(1) of this 
section:
    (i) A is the attachment point, which equals the ratio of the 
notional amounts of all underlying exposures that are subordinated to 
the national bank's or Federal savings association's exposure to the 
total notional amount of all underlying exposures, expressed as a 
decimal value between zero and one; \30\
---------------------------------------------------------------------------

    \30\ In the case of a first-to-default credit derivative, there 
are no underlying exposures that are subordinated to the national 
bank's or Federal savings association's exposure. In the case of a 
second-or-subsequent-to-default credit derivative, the smallest (n-
1) notional amounts of the underlying exposures are subordinated to 
the national bank's or Federal savings association's exposure.
---------------------------------------------------------------------------

    (ii) D is the detachment point, which equals one minus the ratio of 
the notional amounts of all underlying exposures that are senior to the 
national bank's or Federal savings association's exposure to the total 
notional amount of all underlying exposures, expressed as a decimal 
value between zero and one; and
    (iii) The resulting amount is designated with a positive sign if 
the collateralized debt obligation tranche was purchased by the 
national bank or Federal savings association and is designated with a 
negative sign if the collateralized debt obligation tranche was sold by 
the national bank or Federal savings association.
    (iv) Maturity factor. (A)(1) The maturity factor of a derivative 
contract

[[Page 4410]]

that is subject to a variation margin agreement, excluding derivative 
contracts that are subject to a variation margin agreement under which 
the counterparty is not required to post variation margin, is 
determined by the following formula:
[GRAPHIC] [TIFF OMITTED] TR24JA20.021

    Where MPOR refers to the period from the most recent exchange of 
collateral covering a netting set of derivative contracts with a 
defaulting counterparty until the derivative contracts are closed out 
and the resulting market risk is re-hedged.
    (2) Notwithstanding paragraph (c)(9)(iv)(A)(1) of this section:
    (i) For a derivative contract that is not a client-facing 
derivative transaction, MPOR cannot be less than ten business days plus 
the periodicity of re-margining expressed in business days minus one 
business day;
    (ii) For a derivative contract that is a client-facing derivative 
transaction, MPOR cannot be less than five business days plus the 
periodicity of re-margining expressed in business days minus one 
business day; and
    (iii) For a derivative contract that is within a netting set that 
is composed of more than 5,000 derivative contracts that are not 
cleared transactions, or a netting set that contains one or more trades 
involving illiquid collateral or a derivative contract that cannot be 
easily replaced, MPOR cannot be less than twenty business days.
    (3) Notwithstanding paragraphs (c)(9)(iv)(A)(1) and (2) of this 
section, for a netting set subject to two or more outstanding disputes 
over margin that lasted longer than the MPOR over the previous two 
quarters, the applicable floor is twice the amount provided in 
(c)(9)(iv)(A)(1) and (2) of this section.
    (B) The maturity factor of a derivative contract that is not 
subject to a variation margin agreement, or derivative contracts under 
which the counterparty is not required to post variation margin, is 
determined by the following formula:
[GRAPHIC] [TIFF OMITTED] TR24JA20.022

    Where M equals the greater of 10 business days and the remaining 
maturity of the contract, as measured in business days.
    (C) For purposes of paragraph (c)(9)(iv) of this section, if a 
national bank or Federal savings association has elected pursuant to 
paragraph (c)(5)(v) of this section to treat a derivative contract that 
is a cleared transaction that is not subject to a variation margin 
agreement as one that is subject to a variation margin agreement, the 
national bank or Federal savings association must treat the derivative 
contract as subject to a variation margin agreement with maturity 
factor as determined according to (c)(9)(iv)(A) of this section, and 
daily settlement does not change the end date of the period referenced 
by the derivative contract.
    (v) Derivative contract as multiple effective derivative contracts. 
A national bank or Federal savings association must separate a 
derivative contract into separate derivative contracts, according to 
the following rules:
    (A) For an option where the counterparty pays a predetermined 
amount if the value of the underlying asset is above or below the 
strike price and nothing otherwise (binary option), the option must be 
treated as two separate options. For purposes of paragraph 
(c)(9)(iii)(B) of this section, a binary option with strike K must be 
represented as the combination of one bought European option and one 
sold European option of the same type as the original option (put or 
call) with the strikes set equal to 0.95 * K and 1.05 * K so that the 
payoff of the binary option is reproduced exactly outside the region 
between the two strikes. The absolute value of the sum of the adjusted 
derivative contract amounts of the bought and sold options is capped at 
the payoff amount of the binary option.
    (B) For a derivative contract that can be represented as a 
combination of standard option payoffs (such as collar, butterfly 
spread, calendar spread, straddle, and strangle), a national bank or 
Federal savings association must treat each standard option component 
as a separate derivative contract.
    (C) For a derivative contract that includes multiple-payment 
options, (such as interest rate caps and floors), a national bank or 
Federal savings association may represent each payment option as a 
combination of effective single-payment options (such as interest rate 
caplets and floorlets).
    (D) A national bank or Federal savings association may not 
decompose linear derivative contracts (such as swaps) into components.
    (10) Multiple netting sets subject to a single variation margin 
agreement--(i) Calculating replacement cost. Notwithstanding paragraph 
(c)(6) of this section, a national bank or Federal savings association 
shall assign a single replacement cost to multiple netting sets that 
are subject to a single variation margin agreement under which the 
counterparty must post variation margin, calculated according to the 
following formula:

Replacement Cost = max{[Sigma]NS max{VNS; 0{time}  - max{CMA; 0{time} ; 
0{time}  + max{[Sigma]NS min{VNS; 0{time}  - min{CMA; 0{time} ; 
0{time} 

Where:

NS is each netting set subject to the variation margin agreement MA.
VNS is the sum of the fair values (after excluding any valuation 
adjustments) of the derivative contracts within the netting set NS.
CMA is the sum of the net independent collateral amount and the 
variation margin amount applicable to the derivative contracts 
within the netting sets subject to the single variation margin 
agreement.

    (ii) Calculating potential future exposure. Notwithstanding 
paragraph (c)(5) of this section, a national bank or Federal savings 
association shall assign a single potential future exposure to multiple 
netting sets that are subject to a single variation margin agreement 
under which the counterparty must post variation margin equal to the 
sum of the potential future exposure of each such netting set, each 
calculated according to paragraph (c)(7) of this section as if such 
nettings sets were not subject to a variation margin agreement.
    (11) Netting set subject to multiple variation margin agreements or 
a hybrid netting set--(i) Calculating replacement cost. To calculate 
replacement cost for either a netting set subject to multiple variation 
margin agreements under which the counterparty to each variation margin 
agreement must post variation margin, or a netting set composed of at 
least one derivative contract subject to variation margin agreement 
under which the counterparty must post variation margin and at least 
one derivative contract that is not subject to such a variation margin 
agreement, the calculation for replacement cost is provided under 
paragraph (c)(6)(i) of this section, except that the variation margin 
threshold equals the sum of the variation margin thresholds of all 
variation margin agreements within the netting set and the minimum 
transfer amount equals the sum of the minimum transfer amounts of all 
the variation margin agreements within the netting set.
    (ii) Calculating potential future exposure. (A) To calculate 
potential future exposure for a netting set subject to multiple 
variation margin agreements under which the counterparty to each 
variation margin agreement must post variation margin, or a netting set 
composed of at least one derivative contract subject to variation 
margin agreement under which the counterparty to the derivative 
contract

[[Page 4411]]

must post variation margin and at least one derivative contract that is 
not subject to such a variation margin agreement, a national bank or 
Federal savings association must divide the netting set into sub-
netting sets (as described in paragraph (c)(11)(ii)(B) of this section) 
and calculate the aggregated amount for each sub-netting set. The 
aggregated amount for the netting set is calculated as the sum of the 
aggregated amounts for the sub-netting sets. The multiplier is 
calculated for the entire netting set.
    (B) For purposes of paragraph (c)(11)(ii)(A) of this section, the 
netting set must be divided into sub-netting sets as follows:
    (1) All derivative contracts within the netting set that are not 
subject to a variation margin agreement or that are subject to a 
variation margin agreement under which the counterparty is not required 
to post variation margin form a single sub-netting set. The aggregated 
amount for this sub-netting set is calculated as if the netting set is 
not subject to a variation margin agreement.
    (2) All derivative contracts within the netting set that are 
subject to variation margin agreements in which the counterparty must 
post variation margin and that share the same value of the MPOR form a 
single sub-netting set. The aggregated amount for this sub-netting set 
is calculated as if the netting set is subject to a variation margin 
agreement, using the MPOR value shared by the derivative contracts 
within the netting set.

   Table 3 to Sec.   3.132--Supervisory Option Volatility, Supervisory Correlation Parameters, and Supervisory
                                        Factors for Derivative Contracts
----------------------------------------------------------------------------------------------------------------
                                                                    Supervisory     Supervisory
                                                                      option        correlation     Supervisory
         Asset class               Category            Type         volatility        factor         factor 1
                                                                     (percent)       (percent)       (percent)
----------------------------------------------------------------------------------------------------------------
Interest rate................  N/A.............  N/A............              50             N/A            0.50
Exchange rate................  N/A.............  N/A............              15             N/A             4.0
Credit, single name..........  Investment grade  N/A............             100              50            0.46
                               Speculative       N/A............             100              50             1.3
                                grade.
                               Sub-speculative   N/A............             100              50             6.0
                                grade.
Credit, index................  Investment Grade  N/A............              80              80            0.38
                               Speculative       N/A............              80              80            1.06
                                Grade.
Equity, single name..........  N/A.............  N/A............             120              50              32
Equity, index................  N/A.............  N/A............              75              80              20
Commodity....................  Energy..........  Electricity....             150              40              40
                                                 Other..........              70              40              18
                               Metals..........  N/A............              70              40              18
                               Agricultural....  N/A............              70              40              18
                               Other...........  N/A............              70              40              18
----------------------------------------------------------------------------------------------------------------
\1\ The applicable supervisory factor for basis derivative contract hedging sets is equal to one-half of the
  supervisory factor provided in this Table 3, and the applicable supervisory factor for volatility derivative
  contract hedging sets is equal to 5 times the supervisory factor provided in this Table 3.

    (d) * * *
    (10) * * *
    (i) With prior written approval of the OCC, a national bank or 
Federal savings association may set EAD equal to a measure of 
counterparty credit risk exposure, such as peak EAD, that is more 
conservative than an alpha of 1.4 times the larger of 
EPEunstressed and EPEstressed for every 
counterparty whose EAD will be measured under the alternative measure 
of counterparty exposure. The national bank or Federal savings 
association must demonstrate the conservatism of the measure of 
counterparty credit risk exposure used for EAD. With respect to 
paragraph (d)(10)(i) of this section:
    (A) For material portfolios of new OTC derivative products, the 
national bank or Federal savings association may assume that the 
standardized approach for counterparty credit risk pursuant to 
paragraph (c) of this section meets the conservatism requirement of 
this section for a period not to exceed 180 days.
    (B) For immaterial portfolios of OTC derivative contracts, the 
national bank or Federal savings association generally may assume that 
the standardized approach for counterparty credit risk pursuant to 
paragraph (c) of this section meets the conservatism requirement of 
this section.
* * * * *
    (e) * * *
    (6) * * *
    (viii) If a national bank or Federal savings association uses the 
standardized approach for counterparty credit risk pursuant to 
paragraph (c) of this section to calculate the EAD for any immaterial 
portfolios of OTC derivative contracts, the national bank or Federal 
savings association must use that EAD as a constant EE in the formula 
for the calculation of CVA with the maturity equal to the maximum of:
    (A) Half of the longest maturity of a transaction in the netting 
set; and
    (B) The notional weighted average maturity of all transactions in 
the netting set.
    10. Section 3.133 is amended by revising paragraphs (a), (b)(1) 
through (3), (b)(4)(i), (c)(1) thorough (3), (c)(4)(i), and (d) to read 
as follows:


Sec.  3.133  Cleared transactions.

    (a) General requirements--(1) Clearing member clients. A national 
bank or Federal savings association that is a clearing member client 
must use the methodologies described in paragraph (b) of this section 
to calculate risk-weighted assets for a cleared transaction.
    (2) Clearing members. A national bank or Federal savings 
association that is a clearing member must use the methodologies 
described in paragraph (c) of this section to calculate its risk-
weighted assets for a cleared transaction and paragraph (d) of this 
section to calculate its risk-weighted assets for its default fund 
contribution to a CCP.
    (b) * * *
    (1) Risk-weighted assets for cleared transactions. (i) To determine 
the risk-weighted asset amount for a cleared transaction, a national 
bank or Federal savings association that is a clearing member client 
must multiply the trade exposure amount for the cleared transaction, 
calculated in accordance with paragraph (b)(2) of this section, by the 
risk weight appropriate for the

[[Page 4412]]

cleared transaction, determined in accordance with paragraph (b)(3) of 
this section.
    (ii) A clearing member client national bank's or Federal savings 
association's total risk-weighted assets for cleared transactions is 
the sum of the risk-weighted asset amounts for all of its cleared 
transactions.
    (2) Trade exposure amount. (i) For a cleared transaction that is a 
derivative contract or a netting set of derivative contracts, trade 
exposure amount equals the EAD for the derivative contract or netting 
set of derivative contracts calculated using the methodology used to 
calculate EAD for derivative contracts set forth in Sec.  3.132(c) or 
(d), plus the fair value of the collateral posted by the clearing 
member client national bank or Federal savings association and held by 
the CCP or a clearing member in a manner that is not bankruptcy remote. 
When the national bank or Federal savings association calculates EAD 
for the cleared transaction using the methodology in Sec.  3.132(d), 
EAD equals EADunstressed.
    (ii) For a cleared transaction that is a repo-style transaction or 
netting set of repo-style transactions, trade exposure amount equals 
the EAD for the repo-style transaction calculated using the methodology 
set forth in Sec.  3.132(b)(2) or (3) or (d), plus the fair value of 
the collateral posted by the clearing member client national bank or 
Federal savings association and held by the CCP or a clearing member in 
a manner that is not bankruptcy remote. When the national bank or 
Federal savings association calculates EAD for the cleared transaction 
under Sec.  3.132(d), EAD equals EADunstressed.
    (3) Cleared transaction risk weights. (i) For a cleared transaction 
with a QCCP, a clearing member client national bank or Federal savings 
association must apply a risk weight of:
    (A) 2 percent if the collateral posted by the national bank or 
Federal savings association to the QCCP or clearing member is subject 
to an arrangement that prevents any loss to the clearing member client 
national bank or Federal savings association due to the joint default 
or a concurrent insolvency, liquidation, or receivership proceeding of 
the clearing member and any other clearing member clients of the 
clearing member; and the clearing member client national bank or 
Federal savings association has conducted sufficient legal review to 
conclude with a well-founded basis (and maintains sufficient written 
documentation of that legal review) that in the event of a legal 
challenge (including one resulting from an event of default or from 
liquidation, insolvency, or receivership proceedings) the relevant 
court and administrative authorities would find the arrangements to be 
legal, valid, binding, and enforceable under the law of the relevant 
jurisdictions.
    (B) 4 percent, if the requirements of paragraph (b)(3)(i)(A) of 
this section are not met.
    (ii) For a cleared transaction with a CCP that is not a QCCP, a 
clearing member client national bank or Federal savings association 
must apply the risk weight applicable to the CCP under subpart D of 
this part.
    (4) * * *
    (i) Notwithstanding any other requirement of this section, 
collateral posted by a clearing member client national bank or Federal 
savings association that is held by a custodian (in its capacity as a 
custodian) in a manner that is bankruptcy remote from the CCP, clearing 
member, and other clearing member clients of the clearing member, is 
not subject to a capital requirement under this section.
* * * * *
    (c) * * *
    (1) Risk-weighted assets for cleared transactions. (i) To determine 
the risk-weighted asset amount for a cleared transaction, a clearing 
member national bank or Federal savings association must multiply the 
trade exposure amount for the cleared transaction, calculated in 
accordance with paragraph (c)(2) of this section by the risk weight 
appropriate for the cleared transaction, determined in accordance with 
paragraph (c)(3) of this section.
    (ii) A clearing member national bank's or Federal savings 
association's total risk-weighted assets for cleared transactions is 
the sum of the risk-weighted asset amounts for all of its cleared 
transactions.
    (2) Trade exposure amount. A clearing member national bank or 
Federal savings association must calculate its trade exposure amount 
for a cleared transaction as follows:
    (i) For a cleared transaction that is a derivative contract or a 
netting set of derivative contracts, trade exposure amount equals the 
EAD calculated using the methodology used to calculate EAD for 
derivative contracts set forth in Sec.  3.132(c) or (d), plus the fair 
value of the collateral posted by the clearing member national bank or 
Federal savings association and held by the CCP in a manner that is not 
bankruptcy remote. When the clearing member national bank or Federal 
savings association calculates EAD for the cleared transaction using 
the methodology in Sec.  3.132(d), EAD equals EADunstressed.
    (ii) For a cleared transaction that is a repo-style transaction or 
netting set of repo-style transactions, trade exposure amount equals 
the EAD calculated under Sec.  3.132(b)(2) or (3) or (d), plus the fair 
value of the collateral posted by the clearing member national bank or 
Federal savings association and held by the CCP in a manner that is not 
bankruptcy remote. When the clearing member national bank or Federal 
savings association calculates EAD for the cleared transaction under 
Sec.  3.132(d), EAD equals EADunstressed.
    (3) Cleared transaction risk weights. (i) A clearing member 
national bank or Federal savings association must apply a risk weight 
of 2 percent to the trade exposure amount for a cleared transaction 
with a QCCP.
    (ii) For a cleared transaction with a CCP that is not a QCCP, a 
clearing member national bank or Federal savings association must apply 
the risk weight applicable to the CCP according to subpart D of this 
part.
    (iii) Notwithstanding paragraphs (c)(3)(i) and (ii) of this 
section, a clearing member national bank or Federal savings association 
may apply a risk weight of zero percent to the trade exposure amount 
for a cleared transaction with a QCCP where the clearing member 
national bank or Federal savings association is acting as a financial 
intermediary on behalf of a clearing member client, the transaction 
offsets another transaction that satisfies the requirements set forth 
in Sec.  3.3(a), and the clearing member national bank or Federal 
savings association is not obligated to reimburse the clearing member 
client in the event of the QCCP default.
    (4) * * *
    (i) Notwithstanding any other requirement of this section, 
collateral posted by a clearing member national bank or Federal savings 
association that is held by a custodian (in its capacity as a 
custodian) in a manner that is bankruptcy remote from the CCP, clearing 
member, and other clearing member clients of the clearing member, is 
not subject to a capital requirement under this section.
* * * * *
    (d) Default fund contributions--(1) General requirement. A clearing 
member national bank or Federal savings association must determine the 
risk-weighted asset amount for a default fund contribution to a CCP at 
least quarterly, or more frequently if, in the opinion of the national 
bank or Federal savings association or the OCC, there is a material 
change in the financial condition of the CCP.

[[Page 4413]]

    (2) Risk-weighted asset amount for default fund contributions to 
nonqualifying CCPs. A clearing member national bank's or Federal 
savings association's risk-weighted asset amount for default fund 
contributions to CCPs that are not QCCPs equals the sum of such default 
fund contributions multiplied by 1,250 percent, or an amount determined 
by the OCC, based on factors such as size, structure, and membership 
characteristics of the CCP and riskiness of its transactions, in cases 
where such default fund contributions may be unlimited.
    (3) Risk-weighted asset amount for default fund contributions to 
QCCPs. A clearing member national bank's or Federal savings 
association's risk-weighted asset amount for default fund contributions 
to QCCPs equals the sum of its capital requirement, KCM for 
each QCCP, as calculated under the methodology set forth in paragraph 
(d)(4) of this section, multiplied by 12.5.
    (4) Capital requirement for default fund contributions to a QCCP. A 
clearing member national bank's or Federal savings association's 
capital requirement for its default fund contribution to a QCCP 
(KCM) is equal to:
[GRAPHIC] [TIFF OMITTED] TR24JA20.023

Where:

KCCP is the hypothetical capital requirement of the QCCP, as 
determined under paragraph (d)(5) of this section;
DFpref is the prefunded default fund contribution of the clearing 
member national bank or Federal savings association to the QCCP;
DFCCP is the QCCP's own prefunded amounts that are contributed to 
the default waterfall and are junior or pari passu with prefunded 
default fund contributions of clearing members of the CCP; and
DFCMpref is the total prefunded default fund contributions from 
clearing members of the QCCP to the QCCP.

    (5) Hypothetical capital requirement of a QCCP. Where a QCCP has 
provided its KCCP, a national bank or Federal savings 
association must rely on such disclosed figure instead of calculating 
KCCP under this paragraph (d)(5), unless the national bank 
or Federal savings association determines that a more conservative 
figure is appropriate based on the nature, structure, or 
characteristics of the QCCP. The hypothetical capital requirement of a 
QCCP (KCCP), as determined by the national bank or Federal savings 
association, is equal to:

KCCP = [Sigma]CMi EADi * 1.6 percent

Where:

CMi is each clearing member of the QCCP; and
EADi is the exposure amount of each clearing member of the QCCP to 
the QCCP, as determined under paragraph (d)(6) of this section.

    (6) EAD of a clearing member national bank or Federal savings 
association to a QCCP. (i) The EAD of a clearing member national bank 
or Federal savings association to a QCCP is equal to the sum of the EAD 
for derivative contracts determined under paragraph (d)(6)(ii) of this 
section and the EAD for repo-style transactions determined under 
paragraph (d)(6)(iii) of this section.
    (ii) With respect to any derivative contracts between the national 
bank or Federal savings association and the CCP that are cleared 
transactions and any guarantees that the national bank or Federal 
savings association has provided to the CCP with respect to performance 
of a clearing member client on a derivative contract, the EAD is equal 
to the exposure amount for all such derivative contracts and guarantees 
of derivative contracts calculated under SA-CCR in Sec.  3.132(c) (or, 
with respect to a CCP located outside the United States, under a 
substantially identical methodology in effect in the jurisdiction) 
using a value of 10 business days for purposes of Sec.  
3.132(c)(9)(iv); less the value of all collateral held by the CCP 
posted by the clearing member national bank or Federal savings 
association or a clearing member client of the national bank or Federal 
savings association in connection with a derivative contract for which 
the national bank or Federal savings association has provided a 
guarantee to the CCP and the amount of the prefunded default fund 
contribution of the national bank or Federal savings association to the 
CCP.
    (iii) With respect to any repo-style transactions between the 
national bank or Federal savings association and the CCP that are 
cleared transactions, EAD is equal to:

EAD = max{EBRM - IM - DF; 0{time} 

Where:

EBRM is the sum of the exposure amounts of each repo-style 
transaction between the national bank or Federal savings association 
and the CCP as determined under Sec.  3.132(b)(2) and without 
recognition of any collateral securing the repo-style transactions;
IM is the initial margin collateral posted by the national bank or 
Federal savings association to the CCP with respect to the repo-
style transactions; and
DF is the prefunded default fund contribution of the national bank 
or Federal savings association to the CCP that is not already 
deducted in paragraph (d)(6)(ii) of this section.

    (iv) EAD must be calculated separately for each clearing member's 
sub-client accounts and sub-house account (i.e., for the clearing 
member's proprietary activities). If the clearing member's collateral 
and its client's collateral are held in the same default fund 
contribution account, then the EAD of that account is the sum of the 
EAD for the client-related transactions within the account and the EAD 
of the house-related transactions within the account. For purposes of 
determining such EADs, the independent collateral of the clearing 
member and its client must be allocated in proportion to the respective 
total amount of independent collateral posted by the clearing member to 
the QCCP.
    (v) If any account or sub-account contains both derivative 
contracts and repo-style transactions, the EAD of that account is the 
sum of the EAD for the derivative contracts within the account and the 
EAD of the repo-style transactions within the account. If independent 
collateral is held for an account containing both derivative contracts 
and repo-style transactions, then such collateral must be allocated to 
the derivative contracts and repo-style transactions in proportion to 
the respective product specific exposure amounts, calculated, excluding 
the effects of collateral, according to Sec.  3.132(b) for repo-style 
transactions and to Sec.  3.132(c)(5) for derivative contracts.
    (vi) Notwithstanding any other provision of paragraph (d) of this 
section, with the prior approval of the OCC, a national bank or Federal 
savings association may determine the risk-weighted asset amount for a 
default fund contribution to a QCCP according to Sec.  3.35(d)(3)(ii).

0
10. Section 3.173 is amended in Table 13 to Sec.  3.173 by revising 
line 4 under Part 2, Derivative exposures, to read as follows:

[[Page 4414]]

Sec.  3.173  Disclosures by certain advanced approaches national banks 
or Federal savings associations and Category III national banks or 
Federal savings associations.

* * * * *

                             Table 13 to Sec.   3.173--Supplementary Leverage Ratio
----------------------------------------------------------------------------------------------------------------
                                                                          Dollar amounts in thousands
                                                             ---------------------------------------------------
                                                                  Tril         Bil          Mil          Thou
----------------------------------------------------------------------------------------------------------------
 
                                                  * * * * * * *
----------------------------------------------------------------------------------------------------------------
                                      Part 2: Supplementary leverage ratio
----------------------------------------------------------------------------------------------------------------
 
                                                  * * * * * * *
----------------------------------------------------------------------------------------------------------------
                                              Derivative exposures
----------------------------------------------------------------------------------------------------------------
 
                                                  * * * * * * *
4 Current exposure for derivative exposures (that is, net of
 cash variation margin).....................................
 
                                                  * * * * * * *
----------------------------------------------------------------------------------------------------------------


0
11. Section 3.300 is amended by adding paragraphs (g) and (h) to read 
as follows:


Sec.  3.300  Transitions.

* * * * *
    (g) SA-CCR. An advanced approaches national bank or Federal savings 
association may use CEM rather than SA-CCR for purposes of Sec. Sec.  
3.34(a) and 3.132(c) until January 1, 2022. An advanced approaches 
national bank or Federal savings association must provide prior notice 
to the OCC if it decides to begin using SA-CCR before January 1, 2022. 
On January 1, 2022, and thereafter, an advanced approaches national 
bank or Federal savings association must use SA-CCR for purposes of 
Sec. Sec.  3.34(a), 3.132(c), and 3.133(d). Once an advanced approaches 
national bank or Federal savings association has begun to use SA-CCR, 
the advanced approaches national bank or Federal savings association 
may not change to use CEM.
    (h) Default fund contributions. Prior to January 1, 2022, a 
national bank or Federal savings association that calculates the 
exposure amounts of its derivative contracts under the standardized 
approach for counterparty credit risk in Sec.  3.132(c) may calculate 
the risk-weighted asset amount for a default fund contribution to a 
QCCP under either method 1 under Sec.  3.35(d)(3)(i) or method 2 under 
Sec.  3.35(d)(3)(ii), rather than under Sec.  3.133(d).

PART 32--LENDING LIMITS

0
12. The authority citation for part 32 continues to read as follows:

    Authority: 12 U.S.C. 1 et seq., 12 U.S.C. 84, 93a, 1462a, 1463, 
1464(u), 5412(b)(2)(B), and 15 U.S.C. 1639h.


0
13. Section 32.9 is amended by revising paragraph (b)(1)(iii) and 
adding paragraph (b)(1)(iv) to read as follows:


Sec.  32.9  Credit exposure arising from derivative and securities 
financing transactions.

* * * * *
    (b) * * *
    (1) * * *
    (iii) Current Exposure Method. The credit exposure arising from a 
derivative transaction (other than a credit derivative transaction) 
under the Current Exposure Method shall be calculated pursuant to 12 
CFR 3.34(b)(1) and (2) and (c) or 324.34(b)(1) and (2) and (c), as 
appropriate.
    (iv) Standardized Approach for Counterparty Credit Risk Method. The 
credit exposure arising from a derivative transaction (other than a 
credit derivative transaction) under the Standardized Approach for 
Counterparty Credit Risk Method shall be calculated pursuant to 12 CFR 
3.132(c)(5) or 324.132(c)(5), as appropriate.
* * * * *

FEDERAL RESERVE SYSTEM

12 CFR Chapter II

Authority and Issuance

    For the reasons set forth in the preamble, chapter II of title 12 
of the Code of Federal Regulations is amended as set forth below:

PART 217--CAPITAL ADEQUACY OF BANK HOLDING COMPANIES, SAVINGS AND 
LOAN HOLDING COMPANIES, AND STATE MEMBER BANKS (REGULATION Q)

0
14. The authority citation for part 217 continues to read as follows:

    Authority:  12 U.S.C. 248(a), 321-338a, 481-486, 1462a, 1467a, 
1818, 1828, 1831n, 1831o, 1831p-l, 1831w, 1835, 1844(b), 1851, 3904, 
3906-3909, 4808, 5365, 5368, 5371, and 5371 note.


0
15. Section 217.2 is amended by:
0
a. Adding the definitions of ``Basis derivative contract,'' ``Client-
facing derivative transaction,'' and ``Commercial end-user'' in 
alphabetical order;
0
b. Revising the definitions of ``Current exposure'' and ``Current 
exposure methodology;''
0
c. Revising paragraph (2) of the definition of ``Financial 
collateral;''
0
d. Adding the definitions of ``Independent collateral,'' ``Minimum 
transfer amount,'' and ``Net independent collateral amount'' in 
alphabetical order;
0
e. Revising the definition of ``Netting set;'' and

[[Page 4415]]

0
f. Adding the definitions of ``Speculative grade,'' ``Sub-speculative 
grade,'' ``Variation margin,'' ``Variation margin agreement,'' 
``Variation margin amount,'' ``Variation margin threshold,'' and 
``Volatility derivative contract'' in alphabetical order.
    The additions and revisions read as follows:


Sec.  217.2  Definitions.

* * * * *
    Basis derivative contract means a non-foreign-exchange derivative 
contract (i.e., the contract is denominated in a single currency) in 
which the cash flows of the derivative contract depend on the 
difference between two risk factors that are attributable solely to one 
of the following derivative asset classes: Interest rate, credit, 
equity, or commodity.
* * * * *
    Client-facing derivative transaction means a derivative contract 
that is not a cleared transaction where the Board-regulated institution 
is either acting as a financial intermediary and enters into an 
offsetting transaction with a qualifying central counterparty (QCCP) or 
where the Board-regulated institution provides a guarantee on the 
performance of a client on a transaction between the client and a QCCP.
* * * * *
    Commercial end-user means an entity that:
    (1)(i) Is using derivative contracts to hedge or mitigate 
commercial risk; and
    (ii)(A) Is not an entity described in section 2(h)(7)(C)(i)(I) 
through (VIII) of the Commodity Exchange Act (7 U.S.C. 2(h)(7)(C)(i)(I) 
through (VIII)); or
    (B) Is not a ``financial entity'' for purposes of section 2(h)(7) 
of the Commodity Exchange Act (7 U.S.C. 2(h)) by virtue of section 
2(h)(7)(C)(iii) of the Act (7 U.S.C. 2(h)(7)(C)(iii)); or
    (2)(i) Is using derivative contracts to hedge or mitigate 
commercial risk; and
    (ii) Is not an entity described in section 3C(g)(3)(A)(i) through 
(viii) of the Securities Exchange Act of 1934 (15 U.S.C. 78c-
3(g)(3)(A)(i) through (viii)); or
    (3) Qualifies for the exemption in section 2(h)(7)(A) of the 
Commodity Exchange Act (7 U.S.C. 2(h)(7)(A)) by virtue of section 
2(h)(7)(D) of the Act (7 U.S.C. 2(h)(7)(D)); or
    (4) Qualifies for an exemption in section 3C(g)(1) of the 
Securities Exchange Act of 1934 (15 U.S.C. 78c-3(g)(1)) by virtue of 
section 3C(g)(4) of the Act (15 U.S.C. 78c-3(g)(4)).
* * * * *
    Current exposure means, with respect to a netting set, the larger 
of zero or the fair value of a transaction or portfolio of transactions 
within the netting set that would be lost upon default of the 
counterparty, assuming no recovery on the value of the transactions.
    Current exposure methodology means the method of calculating the 
exposure amount for over-the-counter derivative contracts in Sec.  
217.34(b).
* * * * *
    Financial collateral * * *
    (2) In which the Board-regulated institution has a perfected, 
first-priority security interest or, outside of the United States, the 
legal equivalent thereof, (with the exception of cash on deposit; and 
notwithstanding the prior security interest of any custodial agent or 
any priority security interest granted to a CCP in connection with 
collateral posted to that CCP).
* * * * *
    Independent collateral means financial collateral, other than 
variation margin, that is subject to a collateral agreement, or in 
which a Board-regulated institution has a perfected, first-priority 
security interest or, outside of the United States, the legal 
equivalent thereof (with the exception of cash on deposit; 
notwithstanding the prior security interest of any custodial agent or 
any prior security interest granted to a CCP in connection with 
collateral posted to that CCP), and the amount of which does not change 
directly in response to the value of the derivative contract or 
contracts that the financial collateral secures.
* * * * *
    Minimum transfer amount means the smallest amount of variation 
margin that may be transferred between counterparties to a netting set 
pursuant to the variation margin agreement.
* * * * *
    Net independent collateral amount means the fair value amount of 
the independent collateral, as adjusted by the standard supervisory 
haircuts under Sec.  217.132(b)(2)(ii), as applicable, that a 
counterparty to a netting set has posted to a Board-regulated 
institution less the fair value amount of the independent collateral, 
as adjusted by the standard supervisory haircuts under Sec.  
217.132(b)(2)(ii), as applicable, posted by the Board-regulated 
institution to the counterparty, excluding such amounts held in a 
bankruptcy remote manner or posted to a QCCP and held in conformance 
with the operational requirements in Sec.  217.3.
    Netting set means a group of transactions with a single 
counterparty that are subject to a qualifying master netting agreement. 
For derivative contracts, netting set also includes a single derivative 
contract between a Board-regulated institution and a single 
counterparty. For purposes of the internal model methodology under 
Sec.  217.132(d), netting set also includes a group of transactions 
with a single counterparty that are subject to a qualifying cross-
product master netting agreement and does not include a transaction:
    (1) That is not subject to such a master netting agreement; or
    (2) Where the Board-regulated institution has identified specific 
wrong-way risk.
* * * * *
    Speculative grade means the reference entity has adequate capacity 
to meet financial commitments in the near term, but is vulnerable to 
adverse economic conditions, such that should economic conditions 
deteriorate, the reference entity would present an elevated default 
risk.
* * * * *
    Sub-speculative grade means the reference entity depends on 
favorable economic conditions to meet its financial commitments, such 
that should such economic conditions deteriorate the reference entity 
likely would default on its financial commitments.
* * * * *
    Variation margin means financial collateral that is subject to a 
collateral agreement provided by one party to its counterparty to meet 
the performance of the first party's obligations under one or more 
transactions between the parties as a result of a change in value of 
such obligations since the last time such financial collateral was 
provided.
    Variation margin agreement means an agreement to collect or post 
variation margin.
    Variation margin amount means the fair value amount of the 
variation margin, as adjusted by the standard supervisory haircuts 
under Sec.  217.132(b)(2)(ii), as applicable, that a counterparty to a 
netting set has posted to a Board-regulated institution less the fair 
value amount of the variation margin, as adjusted by the standard 
supervisory haircuts under Sec.  217.132(b)(2)(ii), as applicable, 
posted by the Board-regulated institution to the counterparty.
    Variation margin threshold means the amount of credit exposure of a 
Board-regulated institution to its counterparty that, if exceeded, 
would require the counterparty to post variation margin to the Board-
regulated institution pursuant to the variation margin agreement.
    Volatility derivative contract means a derivative contract in which 
the payoff

[[Page 4416]]

of the derivative contract explicitly depends on a measure of the 
volatility of an underlying risk factor to the derivative contract.
* * * * *

0
16. Section 217.10 is amended by revising paragraphs (c)(4)(ii)(A) 
through (C) to read as follows:


Sec.  217.10  Minimum capital requirements.

* * * * *
    (c) * * *
    (4) * * *
    (ii) * * *
    (A) The balance sheet carrying value of all of the Board-regulated 
institution's on-balance sheet assets, plus the value of securities 
sold under a repurchase transaction or a securities lending transaction 
that qualifies for sales treatment under U.S. GAAP, less amounts 
deducted from tier 1 capital under Sec.  217.22(a), (c), and (d), and 
less the value of securities received in security-for-security repo-
style transactions, where the Board-regulated institution acts as a 
securities lender and includes the securities received in its on-
balance sheet assets but has not sold or re-hypothecated the securities 
received, and, for a Board-regulated institution that uses the 
standardized approach for counterparty credit risk under Sec.  
217.132(c) for its standardized risk-weighted assets, less the fair 
value of any derivative contracts;
    (B)(1) For a Board-regulated institution that uses the current 
exposure methodology under Sec.  217.34(b) for its standardized risk-
weighted assets, the potential future credit exposure (PFE) for each 
derivative contract or each single-product netting set of derivative 
contracts (including a cleared transaction except as provided in 
paragraph (c)(4)(ii)(I) of this section and, at the discretion of the 
Board-regulated institution, excluding a forward agreement treated as a 
derivative contract that is part of a repurchase or reverse repurchase 
or a securities borrowing or lending transaction that qualifies for 
sales treatment under U.S. GAAP), to which the Board-regulated 
institution is a counterparty as determined under Sec.  217.34, but 
without regard to Sec.  217.34(b), provided that:
    (i) A Board-regulated institution may choose to exclude the PFE of 
all credit derivatives or other similar instruments through which it 
provides credit protection when calculating the PFE under Sec.  217.34, 
but without regard to Sec.  217.34(b), provided that it does not adjust 
the net-to-gross ratio (NGR); and
    (ii) A Board-regulated institution that chooses to exclude the PFE 
of credit derivatives or other similar instruments through which it 
provides credit protection pursuant to paragraph (c)(4)(ii)(B)(1) of 
this section must do so consistently over time for the calculation of 
the PFE for all such instruments; or
    (2)(i) For a Board-regulated institution that uses the standardized 
approach for counterparty credit risk under section Sec.  217.132(c) 
for its standardized risk-weighted assets, the PFE for each netting set 
to which the Board-regulated institution is a counterparty (including 
cleared transactions except as provided in paragraph (c)(4)(ii)(I) of 
this section and, at the discretion of the Board-regulated institution, 
excluding a forward agreement treated as a derivative contract that is 
part of a repurchase or reverse repurchase or a securities borrowing or 
lending transaction that qualifies for sales treatment under U.S. 
GAAP), as determined under Sec.  217.132(c)(7), in which the term C in 
Sec.  217.132(c)(7)(i) equals zero except as provided in paragraph 
(c)(4)(ii)(B)(2)(ii) of this section, and, for any counterparty that is 
not a commercial end-user, multiplied by 1.4; and
    (ii) For purposes of paragraph (c)(4)(ii)(B)(2)(i) of this section, 
a Board-regulated institution may set the value of the term C in Sec.  
217.132(c)(7)(i) equal to the amount of collateral posted by a clearing 
member client of the Board-regulated institution in connection with the 
client-facing derivative transactions within the netting set;
    (C)(1)(i) For a Board-regulated institution that uses the current 
exposure methodology under Sec.  217.34(b) for its standardized risk-
weighted assets, the amount of cash collateral that is received from a 
counterparty to a derivative contract and that has offset the mark-to-
fair value of the derivative asset, or cash collateral that is posted 
to a counterparty to a derivative contract and that has reduced the 
Board-regulated institution's on-balance sheet assets, unless such cash 
collateral is all or part of variation margin that satisfies the 
conditions in paragraphs (c)(4)(ii)(C)(3) through (7) of this section; 
and
    (ii) The variation margin is used to reduce the current credit 
exposure of the derivative contract, calculated as described in Sec.  
217.34(b), and not the PFE; and
    (iii) For the purpose of the calculation of the NGR described in 
Sec.  217.34(b)(2)(ii)(B), variation margin described in paragraph 
(c)(4)(ii)(C)(1)(ii) of this section may not reduce the net current 
credit exposure or the gross current credit exposure; or
    (2)(i) For a Board-regulated institution that uses the standardized 
approach for counterparty credit risk under Sec.  217.132(c) for its 
standardized risk-weighted assets, the replacement cost of each 
derivative contract or single product netting set of derivative 
contracts to which the Board-regulated institution is a counterparty, 
calculated according to the following formula, and, for any 
counterparty that is not a commercial end-user, multiplied by 1.4:

Replacement Cost = max{V-CVMr + CVMp; 0{time} 

Where:

V equals the fair value for each derivative contract or each single-
product netting set of derivative contracts (including a cleared 
transaction except as provided in paragraph (c)(4)(ii)(I) of this 
section and, at the discretion of the Board-regulated institution, 
excluding a forward agreement treated as a derivative contract that 
is part of a repurchase or reverse repurchase or a securities 
borrowing or lending transaction that qualifies for sales treatment 
under U.S. GAAP);
CVMr equals the amount of cash collateral received from a 
counterparty to a derivative contract and that satisfies the 
conditions in paragraphs (c)(4)(ii)(C)(3) through (7) of this 
section, or, in the case of a client-facing derivative transaction, 
the amount of collateral received from the clearing member client; 
and
CVMp equals the amount of cash collateral that is posted to a 
counterparty to a derivative contract and that has not offset the 
fair value of the derivative contract and that satisfies the 
conditions in paragraphs (c)(4)(ii)(C)(3) through (7) of this 
section, or, in the case of a client-facing derivative transaction, 
the amount of collateral posted to the clearing member client;

    (ii) Notwithstanding paragraph (c)(4)(ii)(C)(2)(i) of this section, 
where multiple netting sets are subject to a single variation margin 
agreement, a Board-regulated institution must apply the formula for 
replacement cost provided in Sec.  217.132(c)(10)(i), in which the term 
CMA may only include cash collateral that satisfies the 
conditions in paragraphs (c)(4)(ii)(C)(3) through (7) of this section; 
and
    (iii) For purposes of paragraph (c)(4)(ii)(C)(2)(i), a Board-
regulated institution must treat a derivative contract that references 
an index as if it were multiple derivative contracts each referencing 
one component of the index if the Board-regulated institution elected 
to treat the derivative contract as multiple derivative contracts under 
Sec.  217.132(c)(5)(vi);
    (3) For derivative contracts that are not cleared through a QCCP, 
the cash collateral received by the recipient counterparty is not 
segregated (by law,

[[Page 4417]]

regulation, or an agreement with the counterparty);
    (4) Variation margin is calculated and transferred on a daily basis 
based on the mark-to-fair value of the derivative contract;
    (5) The variation margin transferred under the derivative contract 
or the governing rules of the CCP or QCCP for a cleared transaction is 
the full amount that is necessary to fully extinguish the net current 
credit exposure to the counterparty of the derivative contracts, 
subject to the threshold and minimum transfer amounts applicable to the 
counterparty under the terms of the derivative contract or the 
governing rules for a cleared transaction;
    (6) The variation margin is in the form of cash in the same 
currency as the currency of settlement set forth in the derivative 
contract, provided that for the purposes of this paragraph 
(c)(4)(ii)(C)(6), currency of settlement means any currency for 
settlement specified in the governing qualifying master netting 
agreement and the credit support annex to the qualifying master netting 
agreement, or in the governing rules for a cleared transaction; and
    (7) The derivative contract and the variation margin are governed 
by a qualifying master netting agreement between the legal entities 
that are the counterparties to the derivative contract or by the 
governing rules for a cleared transaction, and the qualifying master 
netting agreement or the governing rules for a cleared transaction must 
explicitly stipulate that the counterparties agree to settle any 
payment obligations on a net basis, taking into account any variation 
margin received or provided under the contract if a credit event 
involving either counterparty occurs;
* * * * *

0
17. Section 217.32 is amended by revising paragraph (f) to read as 
follows:


Sec.  217.32   General risk weights.

* * * * *
    (f) Corporate exposures. (1) A Board-regulated institution must 
assign a 100 percent risk weight to all its corporate exposures, except 
as provided in paragraph (f)(2) of this section.
    (2) A Board-regulated institution must assign a 2 percent risk 
weight to an exposure to a QCCP arising from the Board-regulated 
institution posting cash collateral to the QCCP in connection with a 
cleared transaction that meets the requirements of Sec.  
217.35(b)(3)(i)(A) and a 4 percent risk weight to an exposure to a QCCP 
arising from the Board-regulated institution posting cash collateral to 
the QCCP in connection with a cleared transaction that meets the 
requirements of Sec.  217.35(b)(3)(i)(B).
    (3) A Board-regulated institution must assign a 2 percent risk 
weight to an exposure to a QCCP arising from the Board-regulated 
institution posting cash collateral to the QCCP in connection with a 
cleared transaction that meets the requirements of Sec.  
217.35(c)(3)(i).
* * * * *

0
18. Section 217.34 is revised to read as follows:


Sec.  217.34   Derivative contracts.

    (a) Exposure amount for derivative contracts--(1) Board-regulated 
institution that is not an advanced approaches Board-regulated 
institution. (i) A Board-regulated institution that is not an advanced 
approaches Board-regulated institution must use the current exposure 
methodology (CEM) described in paragraph (b) of this section to 
calculate the exposure amount for all its OTC derivative contracts, 
unless the Board-regulated institution makes the election provided in 
paragraph (a)(1)(ii) of this section.
    (ii) A Board-regulated institution that is not an advanced 
approaches Board-regulated institution may elect to calculate the 
exposure amount for all its OTC derivative contracts under the 
standardized approach for counterparty credit risk (SA-CCR) in Sec.  
217.132(c) by notifying the Board, rather than calculating the exposure 
amount for all its derivative contracts using CEM. A Board-regulated 
institution that elects under this paragraph (a)(1)(ii) to calculate 
the exposure amount for its OTC derivative contracts under SA-CCR must 
apply the treatment of cleared transactions under Sec.  217.133 to its 
derivative contracts that are cleared transactions and to all default 
fund contributions associated with such derivative contracts, rather 
than applying Sec.  217.35. A Board-regulated institution that is not 
an advanced approaches Board-regulated institution must use the same 
methodology to calculate the exposure amount for all its derivative 
contracts and, if a Board-regulated institution has elected to use SA-
CCR under this paragraph (a)(1)(ii), the Board-regulated institution 
may change its election only with prior approval of the Board.
    (2) Advanced approaches Board-regulated institution. An advanced 
approaches Board-regulated institution must calculate the exposure 
amount for all its derivative contracts using SA-CCR in Sec.  
217.132(c) for purposes of standardized total risk-weighted assets. An 
advanced approaches Board-regulated institution must apply the 
treatment of cleared transactions under Sec.  217.133 to its derivative 
contracts that are cleared transactions and to all default fund 
contributions associated with such derivative contracts for purposes of 
standardized total risk-weighted assets.
    (b) Current exposure methodology exposure amount--(1) Single OTC 
derivative contract. Except as modified by paragraph (c) of this 
section, the exposure amount for a single OTC derivative contract that 
is not subject to a qualifying master netting agreement is equal to the 
sum of the Board-regulated institution's current credit exposure and 
potential future credit exposure (PFE) on the OTC derivative contract.
    (i) Current credit exposure. The current credit exposure for a 
single OTC derivative contract is the greater of the fair value of the 
OTC derivative contract or zero.
    (ii) PFE. (A) The PFE for a single OTC derivative contract, 
including an OTC derivative contract with a negative fair value, is 
calculated by multiplying the notional principal amount of the OTC 
derivative contract by the appropriate conversion factor in Table 1 to 
this section.
    (B) For purposes of calculating either the PFE under this paragraph 
(b)(1)(ii) or the gross PFE under paragraph (b)(2)(ii)(A) of this 
section for exchange rate contracts and other similar contracts in 
which the notional principal amount is equivalent to the cash flows, 
notional principal amount is the net receipts to each party falling due 
on each value date in each currency.
    (C) For an OTC derivative contract that does not fall within one of 
the specified categories in Table 1 to this section, the PFE must be 
calculated using the appropriate ``other'' conversion factor.
    (D) A Board-regulated institution must use an OTC derivative 
contract's effective notional principal amount (that is, the apparent 
or stated notional principal amount multiplied by any multiplier in the 
OTC derivative contract) rather than the apparent or stated notional 
principal amount in calculating PFE.
    (E) The PFE of the protection provider of a credit derivative is 
capped at the net present value of the amount of unpaid premiums.

[[Page 4418]]



                                     Table 1 to Sec.   217.34--Conversion Factor Matrix for Derivative Contracts \1\
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                              Credit       Credit (non-
                                                              Foreign       (investment     investment-                      Precious
         Remaining maturity \2\            Interest rate   exchange rate       grade           grade          Equity      metals (except       Other
                                                             and gold        reference       reference                         gold)
                                                                            asset) \3\        asset)
--------------------------------------------------------------------------------------------------------------------------------------------------------
One year or less........................            0.00            0.01            0.05            0.10            0.06            0.07            0.10
Greater than one year and less than or             0.005            0.05            0.05            0.10            0.08            0.07            0.12
 equal to five years....................
Greater than five years.................           0.015           0.075            0.05            0.10            0.10            0.08            0.15
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ For a derivative contract with multiple exchanges of principal, the conversion factor is multiplied by the number of remaining payments in the
  derivative contract.
\2\ For an OTC derivative contract that is structured such that on specified dates any outstanding exposure is settled and the terms are reset so that
  the fair value of the contract is zero, the remaining maturity equals the time until the next reset date. For an interest rate derivative contract
  with a remaining maturity of greater than one year that meets these criteria, the minimum conversion factor is 0.005.
\3\ A Board-regulated institution must use the column labeled ``Credit (investment-grade reference asset)'' for a credit derivative whose reference
  asset is an outstanding unsecured long-term debt security without credit enhancement that is investment grade. A Board-regulated institution must use
  the column labeled ``Credit (non-investment-grade reference asset)'' for all other credit derivatives.

    (2) Multiple OTC derivative contracts subject to a qualifying 
master netting agreement. Except as modified by paragraph (c) of this 
section, the exposure amount for multiple OTC derivative contracts 
subject to a qualifying master netting agreement is equal to the sum of 
the net current credit exposure and the adjusted sum of the PFE amounts 
for all OTC derivative contracts subject to the qualifying master 
netting agreement.
    (i) Net current credit exposure. The net current credit exposure is 
the greater of the net sum of all positive and negative fair values of 
the individual OTC derivative contracts subject to the qualifying 
master netting agreement or zero.
    (ii) Adjusted sum of the PFE amounts. The adjusted sum of the PFE 
amounts, Anet, is calculated as Anet = (0.4 x Agross) + (0.6 x NGR x 
Agross), where:
    (A) Agross = the gross PFE (that is, the sum of the PFE amounts as 
determined under paragraph (b)(1)(ii) of this section for each 
individual derivative contract subject to the qualifying master netting 
agreement); and
    (B) Net-to-gross Ratio (NGR) = the ratio of the net current credit 
exposure to the gross current credit exposure. In calculating the NGR, 
the gross current credit exposure equals the sum of the positive 
current credit exposures (as determined under paragraph (b)(1)(i) of 
this section) of all individual derivative contracts subject to the 
qualifying master netting agreement.
    (c) Recognition of credit risk mitigation of collateralized OTC 
derivative contracts. (1) A Board-regulated institution using CEM under 
paragraph (b) of this section may recognize the credit risk mitigation 
benefits of financial collateral that secures an OTC derivative 
contract or multiple OTC derivative contracts subject to a qualifying 
master netting agreement (netting set) by using the simple approach in 
Sec.  217.37(b).
    (2) As an alternative to the simple approach, a Board-regulated 
institution using CEM under paragraph (b) of this section may recognize 
the credit risk mitigation benefits of financial collateral that 
secures such a contract or netting set if the financial collateral is 
marked-to-fair value on a daily basis and subject to a daily margin 
maintenance requirement by applying a risk weight to the 
uncollateralized portion of the exposure, after adjusting the exposure 
amount calculated under paragraph (b)(1) or (2) of this section using 
the collateral haircut approach in Sec.  217.37(c). The Board-regulated 
institution must substitute the exposure amount calculated under 
paragraph (b)(1) or (2) of this section for [Sigma]E in the equation in 
Sec.  217.37(c)(2).
    (d) Counterparty credit risk for credit derivatives--(1) Protection 
purchasers. A Board-regulated institution that purchases a credit 
derivative that is recognized under Sec.  217.36 as a credit risk 
mitigant for an exposure that is not a covered position under subpart F 
of this part is not required to compute a separate counterparty credit 
risk capital requirement under this subpart provided that the Board-
regulated institution does so consistently for all such credit 
derivatives. The Board-regulated institution must either include all or 
exclude all such credit derivatives that are subject to a qualifying 
master netting agreement from any measure used to determine 
counterparty credit risk exposure to all relevant counterparties for 
risk-based capital purposes.
    (2) Protection providers. (i) A Board-regulated institution that is 
the protection provider under a credit derivative must treat the credit 
derivative as an exposure to the underlying reference asset. The Board-
regulated institution is not required to compute a counterparty credit 
risk capital requirement for the credit derivative under this subpart, 
provided that this treatment is applied consistently for all such 
credit derivatives. The Board-regulated institution must either include 
all or exclude all such credit derivatives that are subject to a 
qualifying master netting agreement from any measure used to determine 
counterparty credit risk exposure.
    (ii) The provisions of this paragraph (d)(2) apply to all relevant 
counterparties for risk-based capital purposes unless the Board-
regulated institution is treating the credit derivative as a covered 
position under subpart F of this part, in which case the Board-
regulated institution must compute a supplemental counterparty credit 
risk capital requirement under this section.
    (e) Counterparty credit risk for equity derivatives. (1) A Board-
regulated institution must treat an equity derivative contract as an 
equity exposure and compute a risk-weighted asset amount for the equity 
derivative contract under Sec. Sec.  217.51 through 217.53 (unless the 
Board-regulated institution is treating the contract as a covered 
position under subpart F of this part).
    (2) In addition, the Board-regulated institution must also 
calculate a risk-based capital requirement for the counterparty credit 
risk of an equity derivative contract under this section if the Board-
regulated institution is treating the contract as a covered position 
under subpart F of this part.
    (3) If the Board-regulated institution risk weights the contract 
under the Simple Risk-Weight Approach (SRWA) in Sec.  217.52, the 
Board-regulated institution may choose not to hold risk-based capital 
against the counterparty credit risk of the equity derivative contract, 
as long as it does so for all such contracts. Where the equity 
derivative contracts are subject to a qualified master netting 
agreement, a Board-regulated institution using the SRWA must either 
include all or

[[Page 4419]]

exclude all of the contracts from any measure used to determine 
counterparty credit risk exposure.
    (f) Clearing member Board-regulated institution's exposure amount. 
The exposure amount of a clearing member Board-regulated institution 
using CEM under paragraph (b) of this section for a client-facing 
derivative transaction or netting set of client-facing derivative 
transactions equals the exposure amount calculated according to 
paragraph (b)(1) or (2) of this section multiplied by the scaling 
factor the square root of \1/2\ (which equals 0.707107). If the Board-
regulated institution determines that a longer period is appropriate, 
the Board-regulated institution must use a larger scaling factor to 
adjust for a longer holding period as follows:
[GRAPHIC] [TIFF OMITTED] TR24JA20.024

Where H = the holding period greater than or equal to five days.

    Additionally, the Board may require the Board-regulated institution 
to set a longer holding period if the Board determines that a longer 
period is appropriate due to the nature, structure, or characteristics 
of the transaction or is commensurate with the risks associated with 
the transaction.

0
19. Section 217.35 is amended by adding paragraph (a)(3), revising 
paragraph (b)(4)(i), and adding paragraph (c)(3)(iii) to read as 
follows:


Sec.  217.35  Cleared transactions.

    (a) * * *
    (3) Alternate requirements. Notwithstanding any other provision of 
this section, an advanced approaches Board-regulated institution or a 
Board-regulated institution that is not an advanced approaches Board-
regulated institution and that has elected to use SA-CCR under Sec.  
217.34(a)(1) must apply Sec.  217.133 to its derivative contracts that 
are cleared transactions rather than this section.
    (b) * * *
    (4) * * *
    (i) Notwithstanding any other requirements in this section, 
collateral posted by a clearing member client Board-regulated 
institution that is held by a custodian (in its capacity as custodian) 
in a manner that is bankruptcy remote from the CCP, clearing member, 
and other clearing member clients of the clearing member, is not 
subject to a capital requirement under this section.
* * * * *
    (c) * * *
    (3) * * *
    (iii) Notwithstanding paragraphs (c)(3)(i) and (ii) of this 
section, a clearing member Board-regulated institution may apply a risk 
weight of zero percent to the trade exposure amount for a cleared 
transaction with a CCP where the clearing member Board-regulated 
institution is acting as a financial intermediary on behalf of a 
clearing member client, the transaction offsets another transaction 
that satisfies the requirements set forth in Sec.  217.3(a), and the 
clearing member Board-regulated institution is not obligated to 
reimburse the clearing member client in the event of the CCP default.
* * * * *

0
20. Section 217.37 is amended by revising paragraphs (c)(3)(iii), 
(c)(3)(iv)(A) and (C), (c)(4)(i)(B) introductory text, and 
(c)(4)(i)(B)(1) to read as follows:


Sec.  217.37   Collateralized transactions.

* * * * *
    (c) * * *
    (3) * * *
    (iii) For repo-style transactions and client-facing derivative 
transactions, a Board-regulated institution may multiply the standard 
supervisory haircuts provided in paragraphs (c)(3)(i) and (ii) of this 
section by the square root of \1/2\ (which equals 0.707107). For 
client-facing derivative transactions, if a larger scaling factor is 
applied under Sec.  217.34(f), the same factor must be used to adjust 
the supervisory haircuts.
    (iv) * * *
    (A) TM equals a holding period of longer than 10 
business days for eligible margin loans and derivative contracts other 
than client-facing derivative transactions or longer than 5 business 
days for repo-style transactions and client-facing derivative 
transactions;
* * * * *
    (C) TS equals 10 business days for eligible margin loans 
and derivative contracts other than client-facing derivative 
transactions or 5 business days for repo-style transactions and client-
facing derivative transactions.
* * * * *
    (4) * * *
    (i) * * *
    (B) The minimum holding period for a repo-style transaction and 
client-facing derivative transaction is five business days and for an 
eligible margin loan and a derivative contract other than a client-
facing derivative transaction is ten business days except for 
transactions or netting sets for which paragraph (c)(4)(i)(C) of this 
section applies. When a Board-regulated institution calculates an own-
estimates haircut on a TN-day holding period, which is 
different from the minimum holding period for the transaction type, the 
applicable haircut (HM) is calculated using the following 
square root of time formula:
* * * * *
    (1) TM equals 5 for repo-style transactions and client-
facing derivative transactions and 10 for eligible margin loans and 
derivative contracts other than client-facing derivative transactions;
* * * * *


Sec.  Sec.  217.134, 217.202, and 217.210  [Amended]

0
21. For each section listed in the following table, the footnote number 
listed in the ``Old footnote number'' column is redesignated as the 
footnote number listed in the ``New footnote number'' column as 
follows:

------------------------------------------------------------------------
                                           Old footnote    New footnote
                 Section                      number          number
------------------------------------------------------------------------
217.134(d)(3)...........................              30              31
217.202, paragraph (1) introductory text              31              32
 of the definition of ``Covered
 position''.............................
217.202, paragraph (1)(i) of the                      32              33
 definition of ``Covered position''.....
217.210(e)(1)...........................              33              34
------------------------------------------------------------------------


0
22. Section 217.132 is amended by:
0
a. Revising paragraphs (b)(2)(ii)(A)(3) through (5);
0
b. Adding paragraphs (b)(2)(ii)(A)(6) and (7);
0
c. Revising paragraphs (c) heading and (c)(1) and (2) and (5) through 
(8);
0
d. Adding paragraphs (c)(9) through (11);
0
e. Revising paragraph (d)(10)(i);
0
f. In paragraphs (e)(5)(i)(A) and (H), removing ``Table 3 to Sec.  
217.132'' and adding in its place ``Table 4 to this section'';

[[Page 4420]]

0
g. In paragraphs (e)(5)(i)(C) and (e)(6)(i)(B), removing ``current 
exposure methodology'' and adding in its place ``standardized approach 
to counterparty credit risk'' wherever it appears;
0
h. Redesignating Table 3 to Sec.  217.132 following paragraph 
(e)(5)(ii) as Table 4 to Sec.  217.132; and
0
i. Revising paragraph (e)(6)(viii).
    The revisions and additions read as follows:


Sec.  217.132   Counterparty credit risk of repo-style transactions, 
eligible margin loans, and OTC derivative contracts.

* * * *